Published in North American Windpower on July 21, 2016
Written by Conor McKenna
Despite downward pressure on energy prices, wind power remains competitive in many areas of the country. To understand this, it is important to outline the positive trends that are impacting the industry.
Investors are comfortable with the industry’s supply chain. Renewables technology is now exceptionally well-proven. It is boring, and boring is a good thing in this context – profitable for both developers and investors. Manufacturers and engineering providers have streamlined their processes. According to Bloomberg New Energy Finance (BNEF), turbine prices have declined by 26% since 2009 and are expected to fall another 2.3% by 2018. Additionally, average turbine efficiency has increased from 32% in 2014 to 37% in 2016, with current highs eclipsing 50% in the Texas Panhandle region.
Project pipelines are healthy. BNEF forecasts consistent new build coming online in each of the next three years: 8.7 GW in 2016, 7.3 GW in 2017 and 8.8 GW in 2018. Several years ago, investors may have asked, “Is this working?” when referring to a variety of uncertainties surrounding technology viability, project profitability and even if the industry would survive.
Doubt today concerning wind’s place in the U.S. energy mix is gone. There is great confidence in the ability to construct and finance projects. Investors and late-stage developers are buying projects prior to construction. In February, the American Wind Energy Association announced that more than 35% of the new energy capacity coming online in 2015 came from wind – the most of any source.
Government policy (finally) is offering market certainty. The production tax credit (PTC) extension in December gave developers the potential for full subsidy benefits through 2020 – and at reduced rates through 2023. Renewable portfolio standards are expanding in several states and are expected to fuel build as the PTC sunsets.
The wind industry’s strong position – mature supply chain, strong project pipeline and policy support – is attracting new market entrants willing to close deals at lower prices.
Long-term capital providers continue to show increasing interest in wind. As yieldcos have pulled back due to market volatility, a more diversified sponsor base – ranging from private equity and infrastructure funds, pension funds, insurance companies, and traditional independent power producers – has entered the market. These investors are looking for long-term assets with moderate yields. They are also attracted to wind’s scalability compared with other technologies and its project volume and economies of scale, as they seek to invest significant amounts of capital in renewable energy.
Increased competitiveness in the capital markets has enabled capital providers to accept lesser returns. Tax equity investors are more comfortable than ever, with a growing sponsor and lender base. Back leverage products have improved, and lenders are becoming more experienced navigating deals, leading to terms with lower rates and greater transaction efficiencies. The reduced cost of equity and debt has helped maintain long-term investors’ margins in lower-yield environments.
Furthermore, most long-term capital providers maintain low costs of capital themselves. Despite yields declining from a high of 11%-13% levered to as low as 8%-10% levered, investor demand for wind remains strong. Concerns over power purchase agreement (PPA) prices dipping to unprofitable levels in the long term are overstated. The market is large and dynamic enough that the supply of projects and demand from capital providers will find a new equilibrium.
Developers have more certainty today than in prior years. Developers are not absorbing the economic hit of dropping power prices. Investors are willing to take less because the market is strong and there’s a lot of competition for projects. Assets themselves are more de-risked than ever in light of proven technology, high-caliber experienced developers with powerful track records and good regulatory stability – especially with the PTC and other factors driving lower return expectations from capital sources.
Developers are also more knowledgeable of the various tax structures, leading to higher transaction volumes and better efficiencies. In addition to the PTC extension, the IRS clarified its safe harbor rules outlining the criteria by which projects qualify for full subsidies. Developers now have a substantial time frame to fill and construct pipelines.
Growing comfort with wind technology is attracting corporate entities. These are headlined by technology firms and major manufacturers and retailers, such as Google, Amazon, Wal-Mart, IKEA and Dow Chemical. According to BNEF, 2015 was a record year for corporate wind PPA procurement, with more than 2 GW of power contracts inked. Procurement is expected to continue, potentially contributing to lower rates. Although many Fortune 500 firms have sustainability initiatives, nearly all seek the lowest off-take prices.
Challenges
The industry is facing several key concerns in the near term. Without new transmission in some regions, congestion and over-saturation could further suppress rates. Other localities have projects suffering from production underperformance. Projects tied to merchant pricing may continue to face challenges if declining investor returns keep prices near lows. Many of these risks are geographically rooted and are expected to be short-term issues.
Comparing the pricing of wind projects versus conventional energy sources, such as natural gas, creates additional questions. When given a choice, many investors would still rather construct a gas plant because of scale and performance reliability benefits. However, wind projects offer these investors a number of benefits when compared with gas. Wind project PPAs tend to be long term and structured to protect against the downside, while natural gas contracts tend to be shorter term and more exposed to commodity pricing. Furthermore, wind plants have lower operational expenses. These factors offer further incentive for investors to add wind to their portfolios.
Growth in wind markets is expected to continue, fueled by confidence in the industry’s supply chain, project pipelines and government policies. Wind technology has achieved grid parity in several regions with subsidies and is competitive in several Plains States without them.
Author’s note: Conor McKenna is a managing director at CohnReznick Capital Markets Securities. He can be reached at conor.mckenna@crcms.com.
