Several factors are working against utilities buying more wind power. One is that the recession has reduced demand for power in general, so electricity providers no longer need to sign as many power purchase agreements (PPAs). "One of the issues we have right now is that we don't need more electricity supply," said John Anderson, senior managing director at John Hancock Financial Services. "We just had, for the first time in 25 years, two years in a row of falling demand for electricity, including a 3.5% drop last year."
Low natural gas prices and the prospect of a glut in supply as advances in extraction technologies unlock previously inaccessible reserves from shale formations are also having an impact. Utilities that might have been in the market for new wind energy supply are now considering their generation options. "People are looking around and saying I can get other power cheaper," said Armistead. "You have to find markets where people want wind."
A lack of clear policy at the federal level is also playing a role. Developers say without a strong signal from Congress that renewable energy must be part of the supply mix and that carbon will be regulated, utilities in the current market are going to wait and see. "I think it makes a very difficult situation for us," said Wouter van Kempen, president of Duke Energy Generation Services. "The supply side is ready to go, but the demand side needs a push." (See box, page 68.)
The US industry is firmly entrenched in a buyer's market. Where Power Purchase Agreements (PPAs) are available, the competition among wind producers to win them is fierce. Prices being offered are 30-35% lower than market levels, said Mike Storch, executive vice-president of strategy and corporate development for Enel North America. "We are undermining one another in a lot of ways," he said. "I see very few requests for proposals happening where the losers don't come back and offer significantly lower prices. So there's almost this constant revolving door in some cases where the offered prices have to be continuously lowered in order to obtain a contract. And we're not actually seeing a lot of deals close when people get to the point of signing contracts."
The requirements that utilities are placing on developers through those contracts are also becoming increasingly onerous, said Edward Einowski, a partner at law firm Stoel Rives. Many, for example, are looking for output guarantees. They are also increasingly unwilling to consider payments to generators when wind plants are called on to curtail their output. Timelines are tougher and credit requirements more stringent. "Clearly, they are trying to put more risks on generators than has been the case in the past and, when you couple that with declining prices for power, my assumption is generators have less economic muscle to absorb those risks," Einowski said.
As power prices drop, though, things are improving on the project-cost side of the equation. Turbine prices have fallen with demand, although they have yet to settle at a benchmark price. "You need the project first and then you can figure out what the price is," said Armistead. "But I can tell you it has changed. It changes all the time."
Challenge for suppliers
Several panellists argued that equipment costs have to fall further to reflect the prices that wind developers are receiving for the end product. "Where you are setting this as a competition to gas or coal, it is ruthlessly competitive and difficult until the price of the equipment falls to an equilibrium point," said Raymond Wood, a managing director at Credit Suisse.
The good news for developers is that days of 30% down payments for turbines and long lead time on orders are gone. "That has all changed," said Jan Paulin, chief executive of Padoma Wind Power. "We're seeing a tremendous influx of turbine manufacturers to the US market and I certainly hope we will never again see the times we had there for a couple of years where you had to order turbines years in advance without really knowing where they were going, and thus take a much higher degree of risk than is prudent in this industry."
That increased competition, combined with shrinking order backlogs and lower demand for wind, is prompting changes in the way turbine makers approach the market. Pattern Energy recently invited bids from turbine makers - a move that would have been treated as a joke just two years ago, according to Armistead - and received bids from several companies. There are also signs of a return to financing of turbine purchases by the turbine vendor.
"You are seeing a lot of equipment suppliers who have white knuckles and are very much looking to find an edge," said Ted Brandt, chief executive of Marathon Capital, an investment bank that specialises in energy projects. "And so you are absolutely seeing on projects that need capital, that capital coming from the equipment suppliers."
The same holds true for companies that build the projects. General contractors are coming to the negotiating table offering to defer their fees until 60 days after wind projects they have built come online. This move is designed to coincide with the payment time frame of the cash grant covering 30% of eligible project costs that the US government is paying to spur wind energy development, said Ed Zaelke, a partner at law firm Chadbourne and Parke. Some turbine suppliers are prepared to do the same, he added. "We've seen a couple of these deals, and we may see more of them as the market continues to soften for turbine supply."
The fallout from the financial crisis has also had an impact on mergers and acquisitions in the US wind sector. Just a few years ago, European utilities, buoyed by easy credit and a strong euro, were prepared to swoop in and pay a hefty premium for development companies and their pipelines in order to gain a foothold in the US market. After the collapse of the market, most of the companies and projects on the auction block last year were in financial trouble and sold at cut-rate prices.
As the economy picks up, the market is shifting from a focus on projects in distress. "We're certainly seeing all the signs that we're regaining growth," said Brandt. "It's not the irrational exuberance that was there, but clearly it is an improving market." Wood agreed. "The fact that distress is no longer a problem doesn't mean the valuations have skyrocketed," he said. In fact, lower power prices are having an impact on how much the investors who are either looking to enter the US market or expand existing portfolios are willing to pay to acquire development companies and projects. "What we're seeing is that a lot of pressure on price depresses the value of pipelines," Wood said.
Buyers are also more keen for assurances that assets they buy are likely to secure long-term power purchase contracts. "I do think what you're seeing in this market is 100% focus for virtually all the guys with money on PPA-backed projects or very, very late-stage projects," said Brandt.
That is a big change from pre-crisis days, when interest was high in assets located in competitive wholesale power markets where developers were able to play off high and volatile natural-gas prices to get wind plants built even without long-term power purchase agreements, in so-called merchant projects. They did that by arranging hedges with financial institutions that would pay the producer if electricity prices dropped below a floor value and take any upside if rates rose above a set ceiling.
We saw great values when gas prices were high," said Wood. "There were a lot of merchant strategies that were worth their weight in gold. That is, putting up a wind farm and getting a hedge in markets where gas prices were correlated with power prices, for example, in Texas. You saw enormous value propositions. With readily available debt you could understand why private equity and everybody else was jumping in to make four or five times their money."
With credit still tight, fewer hedge providers and project financiers are willing to take a bet on the future path of energy prices. But despite Brandt's assessment, there are companies in the mergers-and-acquisitions market who are still interested in taking advantage of opportunities when and where they can forego a PPA. Virginia-based Apex Wind Energy is bullish on the long-term future of power prices, renewable energy credit values and carbon policy, said chief financial officer Jim Trousdale. "We like merchant markets quite a bit," he said. "The request-for-proposals process to get a power contract with a utility is pretty daunting with all of the developers out there."
Wood says developers in the current market should continue building pipelines and await the improvements Apex is anticipating before looking to sell either their companies or project assets. "If you can do that without acquiring external capital and prepare for a market environment where we're pricing carbon and where demand picks up, I think you can create a lot of value," he said.
Brandt agreed: "We do think that amassing a portfolio of early-stage projects that you develop along right now is a relatively low-cost strategy. The market will turn in 2012 and 2013 and those will have a lot of value."