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United States

Tax credit cliff hanger with changing dynamics -- Familiar US market risk hits new players on a different stage

The United States wind power market is once more teetering on the edge of another precipitous drop into the void. Yet again the wind industry is struggling to retain its production tax credit (PTC), a $0.02/kWh financial primer that drives most of the investment in the sector. This time, however, the dynamics of the situation have significantly changed. In a market where developers have sunk millions into securing turbines several years in advance, the potential fallout from the failure of the US Congress to extend the PTC as part of its $168 billion economic stimulus package represents a new set of challenges. Others see opportunities.

"Developers are making very long term commitments, placing very big bets, hundreds of millions of dollar bets, that the PTC will be extended. These contracts, which are firm commitment contracts for developers, provide for turbine delivery in 2009 and in some cases 2010. So the market is pretty far extended right now in terms of PTC risk," says Jeffrey Chester of law firm Kaye Scholer LLP. "Unless we get an extension in the first half of this year you are going to see a big drop off in 2009. You are going to see a lot of hurt in the market." Chester was speaking at Infocast's Wind Power Finance and Investment Summit in San Diego last month.

The PTC is set to expire at the end of 2008 and for those who have bought turbines for next year, says Jan Paulin of California-based Padoma Wind Energy, there are not a whole lot of options if it is allowed to lapse. "You have got to receive those turbines and either you build the project or you store the turbines. Either alternative is rather undesirable." At the same time, though, Paulin is confident the PTC will ultimately be extended. And even if an extension is not finalised until next year, he says, it will likely be retroactive.

It is a view overwhelmingly shared by the rest of the US wind industry and that, combined with the growing presence of large international players in the market, could mean the impact of a PTC expiration is different than when it last happened at the end of 2003. At that time, project construction essentially came to a standstill until the credit was renewed in September 2004.

New times

"It will be interesting to see if some of the new participants in the market with very strong balance sheets start to build these projects on their balance sheets in expectation of a PTC," says Timothy Howell of GE Energy Financial Services. "It will be interesting to see if things are different than in 2004 because of the different set of participants and their capability to take a bet."

John Eber of JP Morgan Capital Corporation, a player in the tax equity side of the business, believes the big new players in the market will keep building. "They are all planning on it. The projects are going to continue to flow along. They just may not be out in the market seeking commitments from us until we know not only whether there is a PTC but what it is worth," Eber says. "Tax equity" for wind farms has been an important source of finance. It is provided by investors simply seeking to bring down their tax bills. For every kilowatt hour of wind power produced, the PTC represents a $0.02 deduction off the taxable earnings of the owner-investor.

In the past, says Theo DeWolff of Robcar Investments LLC, it was the wind turbine manufacturers who were forced to take on the risk of the PTC disappearing because project developers only ordered turbines when they needed them. With developers securing turbines way ahead of their deployment, that has now changed.

"This is the first time we have faced an interruption in the PTC where the risk has been shifted to the developers. If the PTC does not get extended until the end of the year or maybe even next year, then I think the real players in this market will emerge," he says. Mark Tallman of PacfiCorp, a utility serving six western US states, says his company will probably be willing to take some risk. "We'll probably take on projects, but it is not going to be the same as if the PTC was in place," he says.

From Spain's Acciona Energy, a developer-owner, CEO Peter Duprey expects the market will start to see deals that will not get financed "probably in the next few months" as lenders and investors start to pull back. Already turbine supply loans are getting more difficult, says Michael Midden of Dexia Credit Local. "Syndications on turbine supply lendings are taking longer to get done and this is just a function of the market and being right on the edge of a PTC deadline. Banks get very sensitive to this," he says.

Gisela Kroess of UniCredit-HVB says her bank has not financed any 2009 purchases yet. "We still find it hard to speculate about the value of turbines if there is a substantial oversupply in the market. Certain projects depend on the PTC to be economic and go forward," she says. The belief in the industry is that some have ordered too many machines.

Rising power prices, however, do mean the PTC is not as large a piece of the economic equation as it used to be, says Tristan Grimbert of Enxco, a California-based developer. "If there is no PTC the market will readjust," he says.

Show will go on

One possible outcome could be power purchase agreements that offer higher pricing if the PTC is not extended, says William Marder of Fortis Capital Corporation. Fortis, he says, is working on a geothermal deal now with a price adjustment mechanism built in. "I don't know if that is something we are going to be seeing in the wind space."

While tiered pricing is a possibility, says Tallman, it does not alleviate a more fundamental issue for utilities facing state renewables portfolio standards (RPS) requiring a proportion of green power in the supply mix: when to take the market plunge without the PTC. "If you are going to tack on anther $20/MWh to the cost of a project, is it the right decision for that period in time. I would submit, because it is such a large step function, it is probably going to cause utilities who have RPS compliance issues to start thinking about the balance between do I comply now or later," he says. "Most of the urgency we've got is this insatiable cost escalation that has been going on. The notion is you get in there now because it doesn't seem to be slowing down. The loss of the PTC changes the balance of that equation."

On a global level, says Suzlon's Leif Andersen, the PTC may not be as important as it once was. "Yes, if we don't get a PTC the capacity in the US will go down, but guess what? It is a global market for most of us and we will just add capacity in other parts of the world," he says.

"I think we are not as sensitive anymore to political changes in the US. It has been a pain for a very long time with this roller coaster mentality we've had in the political arena. It is not as important anymore. Yes, we still need the PTC. But we are not going to go away and we are not going to disappear if the PTC is not extended."

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