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A New sophistication behind utility ownership

In the United States, utilities have historically used power purchase agreements (PPAs) with independent wind station owners to add wind power to their supply mixes. Increasingly, however, they are looking to capture the financial and operational efficiencies that owning their own projects can bring. It all adds up to cheaper electricity.

The arguments for utilities to own wind stations rather than be mere purchasers of wind power are becoming ever more numerous and sophisticated. It all adds up to cheaper electricity

In the United States, utilities have historically used power purchase agreements (PPAs) with independent wind station owners to add wind power to their supply mixes. Increasingly, however, they are looking to capture the financial and operational efficiencies that owning their own projects can bring. "If you looked in this space three, four or five years ago there was very little in the way of large-scale utility ownership," according to Michael Didriksen of law firm Dewey & LeBoeuf, speaking at Infocast's recent Wind Power Finance and Investment Summit in San Diego. "That situation has been slowly changing."

Building wind power generation into the rate base allows utilities to earn a rate of return on the investment, said Elias Hinkley of Deloitte Tax LLP, something they cannot do on purchased power. "There are also efficiency factors with respect to operation, intermittency issues and transmission issues," he said. But for utilities that are now stepping in to wind farm ownership, there are other motivations as well.

Reducing cost of capital

Xcel Energy takes the output from about 2800 MW of wind on the four utility systems it operates in eight Western and Midwestern states. All of the power is bought under contract. But President Paul Bonavia says the company now wants to own projects as well. In its resource plans for Minnesota and Colorado, Xcel has proposed soliciting bids from wind project developers interested in working with it to make that happen. "It is a question of balance. Between wind and natural gas-fired capacity. Particularly in our Colorado company, we have got more PPA obligation than anybody in America," said Bonavia.

Credit rating agencies treat PPA obligations as imputed debt, explained Bonavia, and the added debt burden can end up raising the interest rates the utility has to pay. "We think some of the cost of capital that is imposed on the utility from an excessive amount of PPAs is ultimately a cost that suggests it is better for the customer not to keep piling that on."

Consumers can also benefit from lower cost wind because of the cheaper financing options utilities have in the rate-based model, said Bonavia. And for Xcel, the customer is king. "Ultimately the one and only test that will determine whether this really happens is whether it is best for our customers. If not, nothing happens. If so, nothing is going to stop it," said Bonavia.

Puget Sound Energy (PSE) in Washington State started early on looking at ownership rather than offtake agreements, said the utility's Roger Garratt. In 2005 it completed its 150 MW Hopkins Ridge project, followed by the 229 MW Wild Horse wind farm in 2006. The desire to own and operate its own plants came partly out of the western electricity market crisis in 2000 and 2001, when gaming of the partially deregulated California energy system led to extremely high and unstable prices. "Certainly the conclusion our utility came to as a result of that was that we needed to have a lot more control over our destiny in terms of resources," said Garratt.

Wind means less risk

PSE has historically counted on power purchase contracts, dating back to hydro PPAs in the 1950s and agreements with cogeneration operators in the 1990s, and that has had an impact as well. "We really had a financial situation where, based on what the weather did or what fossil fuel prices did, we could see too much volatility in our earnings. One of the ways to manage that from a strategic perspective was to own more of our resources," Garratt said.

PacifiCorp, which operates in six western states, owns 344 MW of wind that is either on line or under construction and has announced plans to build 198 MW more. Owning the assets will help the utility maintain the "most reasonable cost exposure to the market over time" by giving it the option of repowering projects at the end of their economic life, said the utility's Mark Tallman. That is especially important, he said, in light of renewable energy portfolio standard (RPS) legislation, which sets minimum levels for the proportion of green power in the supply mix in three of the states in which it operates.

"It is our view that the things you are seeing now in terms of RPS requirements probably aren't going away anytime soon, so we are trying to step back and maybe take as much as a 100 year view," he said. "If you have a piece of property that is windy and is a good wind project site, it is probably going to be a good wind project site for a long, long time."

While Xcel is hoping to make its first foray into ownership with the help of private developers, both PSE and PacifiCorp have decided they want to do more of the development work themselves.

PSE bought the development rights for its two wind projects and managed the construction. Meeting the Washington State RPS of 15% by 2020 will require adding about 1000 MW more. "It is our conclusion that in order to get there, we need to move up the chain. So we are looking at cases where we acquire the development rights at a pretty early stage, where perhaps there is only a land lease and gleam in the developer's eye. And we are looking at some joint venture arrangements," said Garratt.

Less slash and burn

PacifiCorp has also evolved to the point where it is acquiring leases from developers and doing the permitting and construction itself. The fact that utilities have a long term presence in communities it serves can be a big factor in garnering support for a project, Tallman said. "To the extent there is controversy, we are going to take a position that is perhaps a bit more middle ground to make sure at the end of the day we are going to get something that works for us and works for the community as well," he said. "There is less of a slash and burn mentality, if you will, in terms of our approach to development."

Competing for scarce turbines with more nimble independent developers might be a problem in the short term, said Bonavia, but over the long term "just the sheer size of what we are talking about doing" is going to position them to get the technology they need.

Turbine makers, the "original equipment manufacturers" (OEMs), are also going to find it beneficial to develop strong relationships with utilities, said Garratt, not least when it comes to integrating wind power into power systems not yet designed to cope with it. "There is a factor, from an OEM perspective, of needing the utility participation and support as integration issues get more complicated. Certainly the more wind we add to the system, the more these issues come into play."

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