United States

United States

Grappling with an overheated market

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Given a forum for open and frank debate, wind project developers in North America made good use of it to air grievances about steeply rising technology costs, weaker manufacturer warranties and the downsides of the PTC. Some questioned whether the wind industry was pricing its product out of the energy market. Others argued that wind power purchase prices will go up in recognition of its market advantages

Rising costs and increasing risk are not only making life more difficult for US wind power developers today, but some fear they could have a negative impact on the long term health of the industry. "The problems the industry faces at this juncture centre around capital cost. Capital cost has gone through the roof, whether it is turbine costs, transportation costs or balance of plant costs, and it is making it increasingly difficult to make the economics work on wind projects," says Jan Paulin, CEO of Padoma Wind Power, a wind project developer based in California.

While Paulin accepts that more costly raw materials, component bottlenecks, return requirements and unfavourable exchange rates are factors in turbine cost increase, he believes there are other market forces at work as well. Among these is the entry of newcomers to the business who are "very long on capital resources but very short on experience" when it comes to what it should take for a manufacturer to sell a turbine.

"What we are seeing in this market today is very close to what I would call insanity. The insanity is that all of us on the buyer side will not only pay extraordinary sums for turbines, but it has become customary to take less of a warranty on a $3 million turbine than you get on a $20,000 automobile," he says.

"That, at the end of the day I think, is going to create significant problems for the industry. If and when we see a repeat of what historically has been a problem with turbine technology materialise -- and see significant failures and limited or no warranties to force the manufacturers to deal with those failures -- I think the industry is being put at risk." Paulin was talking to a full house of delegates at Infocast's recent Wind Power Finance and Investment conference in San Diego. Padoma was acquired by NRG Energy, a wholesale power generation company with a portfolio of nearly 24,000 MW worldwide, for an undisclosed sum last July. Prior to the acquisition, Padoma was involved in the development of six wind projects with a combined capacity of more than 500 MW, the last of which reached commercial operation in December 2005. Padoma did not put any wind plant online during 2006.

Warranty period

Paulin's concern about weaker turbine warranties is shared by Niels Rydder of Oak Creek Energy Systems, another California developer. "The strong warranty and the competitive market was really what kept the manufacturers honest in producing a reliable long term product. We are now in a position where the manufacturers don't really have to live up to anything," he said. "I am concerned the pressure of short term profit is going to be a temptation for the manufacturers to think more short term in their design."

FPL Energy's Dean Gosselin is not as concerned about shorter warranty periods. These days he believes the industry can establish within two years of operation if there are systemic failures across a particular turbine platform. "Quite frankly, that is why the industry in the US is generally at two years when it comes to warranties," he said. "Europe migrated to ten years because they have enough margin and the banks were insisting on it," he added, referring to the longer warranties required in Germany (Windpower Monthly, July 2002).

But Gosselin agrees with Paulin that turbine price increases are a significant concern facing the US market. "We have seen a sixty per cent increase in turbine prices, which is seventy to eighty per cent of the total project price and it is not sustainable," he said. "We are seeing demand destruction in our backyard. We are seeing customers, future customers, the people ultimately representing the ratepayer or the buyers of power at the retail level, sitting on the sidelines and saying we'll wait it out."

While Gosselin acknowledged prices had to rise to ensure manufacturers an adequate rate of return, he argued that has now been accomplished. "I think for once, as we look at the publicly traded vendors that we can analyse, they are making money," he said. "So the question really comes back to, how much more money does the industry need to make to be sustainable if it is going to ask for more price increases, or is it going to flatten out on prices?"

Future prices

While Suzlon's Leif Andersen told delegates that manufacturers are working to stabilise pricing, he also warned there could be future increases. Part of the issue for the US market, he explained, is that it has historically been, and still is, a low price market for wind power. "The problem is the whole world market has exploded and if you can sell your turbines in other parts of the world at a higher margin it is very tempting to do so," he said. "My biggest battles are actually internal to try to get capacity allocated. Why do we want to sell it in the US if we can get more money in other parts of the world? We all understand that the US is and will always be a major part of the world market, so we need to be here. But the prices need to go up, and that is the PPA prices we are talking about," he said, referring to power purchase agreements (PPAs).

For big international developers who are entering the US market from their European bases, the situation presents what Iberdrola's Eric Blank called an "odd dichotomy." At the project level, a market that offers a significant premium for wind, like Spain, is more attractive. "But at the same time, because of the growth opportunity in the US, even with tighter projects and more competition, it seems like turbines are more valuable placed in the US."

Clipper Windpower's Charles Vaughn acknowledged that while turbine prices have risen and with them the price of wind power for customers, utilities looking to add new generation have faced cost increases across the whole range of generation technologies. "I think if you look at wind as a competitive form of generation versus all the alternatives out in the market, wind has to be a good value in order to compete. And I think, based on the volume of orders that Clipper has received and others have received, it seems wind is still a good value in the market."

Gosselin, however, argued there is cause for concern. He pointed out that wind power in the US used to sell for $0.025-0.040/kWh with the production tax credit factored in, but in today's market the price ranges from $0.045-0.075/kWh. "We used to sell energy on an economic basis. We sell energy now on a political regulatory basis," he said. "And yes, I believe other forms of energy have gone up. But when we talk about plant being added, that is capacity. Nobody here sells capacity out of a wind turbine. We sell energy. We have to compete on marginal energy. If we don't, we're out of the business."

One advantage wind does have in that competition, said Blank, is price stability. "I don't think we need high energy prices. Even volatile energy prices are enough to make wind go."

Gouging effect

The cost increases the industry is grappling with are not limited to turbines. Craig Mataczynski, president of RES Americas, told delegates that the cost to transport a turbine to a site in Texas is now almost 20% of the cost of the equipment. "On top of that you have landowners. The land costs in Texas, for example, have gone up sixty or seventy per cent in the last two years when you take into account things like the royalty structure people are asking for, the upfront payment for damages, things of that nature. Transformers have also gone up by sixty to seventy per cent, and cable has gone up by a similar amount," he said.

"You throw all of these dynamics into the pot and you see a situation where wind is on the very upper edge of what is sustainable in the market place today at a time when gas is not only stabilised, but may be coming down a little bit. It really begs one to ask the question, what are the long term prospects for the industry if this dynamic continues? The US customer will, at the end of the day, accept the fact that wind is a good thing and they will pay a little bit extra for it. But this is the US and they also vote with their pocketbook, and if things get too far out of control we are going to see a downturn in the industry."

Mataczynski is not convinced all the cost increases are justified. Transportation charges rose with oil prices, he said, but did not come down when petroleum prices did. "I think there is a bit of a, dare I use the word, gouging effect going on out there. People see an ability to extract a premium and that is what they are doing."

Tax credit premium

A number of panellists pointed out that US wind policy has had its own impact on the cost issues facing the wind industry. Although the $0.019/kWh production tax credit (PTC) is now in place until the end of 2008, its historical instability has meant wind is more expensive than it needs to be. "I think there is probably a $10 premium on the cost of producing energy right now that you could trace back to the boom-bust, one-year extension type world," said Airtricity's Declan Flanagan.

The need to find investors with "tax appetite" that can actually use the tax credit to reduce their tax bills makes it an inefficient support mechanism, said Mark Anderson of Eurus Energy America, who was participating on a panel of large foreign-owned developers active in the US. "None of us here have tax liability in the US, so we all have to spend money trying to figure out structures to offload those tax credits so somebody who can use them."

Although returns for that tax equity have dropped, it is still not as cheap as other sources of financing developers can access in markets that take a more market-based approach to supporting wind, said Flanagan. "As equity goes, the PTC money in a project is relatively expensive compared to debt which you could put at high levels on projects in a market like the UK."

Preparing for change

The tax credit has also played a role in utility expectations of low priced wind power. "The PTC has had a lot of unintended negative effects, and perhaps the biggest one is that in the case of some utilities they looked at it as a subsidy for the price of power," said David Perlman, managing director of Fieldstone Private Capital Group. "The PPAs they offered got skinnier and skinnier until the combination of the PTC and the skinny PPA was equivalent to what you could have gotten with just the PPA a few years before."

Although some speakers argued strenuously about the need to move from the PTC to a support structure like a national renewables portfolio standard (RPS) based on green energy credit trading, others urged caution. The PTC pays roughly one-third the capital cost of a wind project, pointed out Rydder, something an RPS could not match."I would like to see a long term PTC that is phased out over five or ten years so we know what the goal is. At the same time we can introduce an RPS and scale it up. We can't have this change from one day to the other."

One of the outcomes of the hike in equipment costs, noted FPL's Mike O'Sullivan, is that the accelerated tax depreciation allowed on wind power assets, which gives owners the ability to deduct most of the cost of the project over five years, is now worth more than the PTC. "That is something that is helping sustain some of the build that is going on right now. But it is a bad thing to be proud of."

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