The phase out of the production tax credit is supposed to wean the wind industry off subsidies. After all, the wind industry has been built to a critical mass and can carry on without it, or so the thinking goes. That may not be the case said Edward Einowski, partner with legal consultant Stoel Rives Energy Group, in a conversation at the recent AWEA Windpower 2017 conference. He is the senior partner in the firm’s energy and finance practice. He had more to say on how the PTC ramps down, wind industry construction after the PTC, and what may give a boost to the wind and utility industry.
Edward Einowski is a, partner with legal consultant Stole Rives Energy Group.
Phase out and fall out
As we write, the PTC is in step-down mode, making its payout a moving target. After all, the wind industry has been built to a critical mass and can carry on without it, or so the thinking goes. After that, the developer has a relatively long period to complete construction. “For example, we have projects that were brought under the five-percent rule in 2016 that won’t complete until 2018. But, if they meet the requirements of the grandfather rules, they will still get the benefit of the full 2016 PTC, $24 per megawatt-hour. “For wind projects that ‘begin construction’ in 2017, the credit drops to $19.20/MWh. For projects that ‘begin construction’ in 2018, the credit will be 60% of the 2016 level and 40% of the 2016 level for projects that begin construction in 2019,” said Einowski.
Eventually, the credit disappears. However, the wind industry is showing little interest in a 40% PTC by 2018. Some industry players have opined that when the PTC drops to 40% of its current levels, tax equity transactions that serve to monetize the credit will become less attractive to developers and other financing structures, such as traditional project debt financing, may supplant tax-equity financing. “Wind has become very competitive with natural gas and more competitive than solar, but that’s with the 2016, $24 per MWh subsidy. I don’t know of any projects under construction that were not grandfathered in 2016 so as to be able to secure the full $24 per MWh credit. The sponsors of all projects our office is currently working on that will be completed in 2017 and 2018 have taken steps to qualify under the begin construction rules in order to get the full 2016 PTC. From what I have heard, that seems to be true in the market as a whole. We see a good slice of the market, but no one sees everything, so it is likely that work is proceeding on a wind project that will not qualify for the full 2016 PTC. Be that as it may, the market hasn’t yet begun to test in any significant way what will happen with the lower subsidies in future years.”
Construction like this at Fire Island, Alaska, may become a rarer sight as the production tax credit phases out.
A number of things can serve to keep wind power competitive as the subsidy drops. “For one, the capital costs of a project could decrease. As we have seen in the past, this is possible as turbine manufacturers continue to improve the efficiencies of their operations and take advantage of the economies of scale that come with producing more turbines for the market. But capital costs are only part of the picture because other factors affect the all-in cost-per-MW-hour of energy produced. For example, we have seen significant improvement in the efficiency of the equipment, and hence the amount of output generated by the same installed nameplate capacity. Some of the equipment improvements to date have been mechanical — for example, increased hub heights — while others have involved improved software that better optimizes the output generated by the turbine. To the extent the equipment continues to improve from an efficiency or output standpoint, this will help maintain wind’s competitive posture.”
The capacity factor (the wind resource) of the project is another key factor. “For example, if the turbine price stays the same but it produces more power or the project is located on a more windy site, the effect is to reduce the cost per unit of energy production,” said Einowski. “Optimizing the project site design to take better advantage of the wind resource can also improve production.”
“The popularity in many sectors of ‘going green’ can also help maintain the construction of new wind projects. At the consumer level, many utilities offer ‘green energy’ programs to customers where the customer pays a premium over the standard rate for renewable energy. “These programs have generally been successful, and prove that the consumer sees the greater value of non-emitting resources and is willing to pay a higher price for their output,” he said.
As with consumers, various major industrial and commercial concerns have also taken steps to “green up” their energy supply, which they view as important to being responsible corporate players in the economy. Some may also be seeking to avoid potential liabilities that may come down the road as a result of carbon emissions from their operations. “The last few years have seen a growing number of these “commercial and industrial” off-take arrangements that let business directly contract to get the benefits of clean wind energy. A growing percentage of the projects currently moving forward are supported by such arrangements, and there is every indication that the trend will continue. Thus, even though most states have met their RPS goals and the U.S. has pulled out of the Paris accords, the private sector continues to place great value on these renewable resources and has a growing presence in keeping the wind industry moving forward with new construction,” he said.
Natural gas powered generators such as this one from GE Jenbocker provide fast starts, less than 10 minutes, to minimize spinning reserves and allow cycling up and down more quickly than other generators.
Another growth driver for renewable-energy firms and utilities are the big-name companies committing to offtake arrangements. The companies include the likes of Apple and Google and they are shaping a great new market. “There was a time when it was only possible to sell to utilities. Now, this new market arises for the renewable-energy industry. It’s a driver for a lot of development. In fact, utilities over the last year or two have tended to buy less wind than in prior years, while what we call the commercial-industrials have significantly increased their purchases. The trend has actually helped to move a number of wind projects along that otherwise wouldn’t have been built. It’s a good market that developers are very excited about,” said Einowski.
“There are also issues when companies don’t buy from conventional utilities. For instance, if a big company switches its power purchase for a 300-MW load from a utility to a wind farm, what happens to the 300 MW of resources the utility had been generating to serve them?”
It’s one thing for a large company installing a new server facility for the Internet to buy a couple hundred megawatts. “That would be new load and might not create a larger issue. But when talking about a manufacturing company that has been buying power from a utility and suddenly switches the purchase to a wind farm, then you get some displacement at the utility,” he said.
Some in the wind industry are hoping that tax reform might make a wind farm as profitable as did the PTC. But Einowski does not think that likely if the main impact of tax reform is to eliminate deductions, credits, and other “loopholes” while lower marginal rates. “When talking about tax reform that affects marginal rates, you’re talking about a return to investors. So if I’m a tax-equity investor in a 35% marginal rate, and I was looking to invest in a production tax credit from a wind farm, then the tax credit is worth more than if I’m in a 20% marginal rate bracket. And that assumes that the PTC will survive tax reform, something which is highly doubtful given that it is already slated to sunset and the oft-stated goal of eliminating deductions and credits. The same thing is true for things like depreciation deductions — they are worth more as a tax shelter at a 35% marginal rate than they are at a 20% marginal rate. So tax reform alone may not offer any direct hope for maintaining wind’s competitiveness. If it truly were to spark an economic boom — something that seems doubtful based on past experience — then, of course, wind would benefit along with the rest of the economy.”
How utilities are changing
There are two things a power plant owner can sell: energy and capacity. Energy is the electrons produced, while capacity is a way of looking at the size of the power plant — its maximum possible output. This idea of energy capacity is needed to balance the grid load to resources. One way this is done is to have more capacity than demand needed most of the time.
“In fact, if a grid does not have more capacity available than demand, this grid will have reliability problems because sooner or later a generator somewhere will go off line, letting demand exceed supply, and that power shortage leads to black outs. Grid operators plan to have more resources available on average than demand at any given time because if a power plant goes down, the utility better have some power plants that can respond quickly to keep the lights on,” said Einowski.
To handle the issue of occasional maximum loads, some regional transmission organizations — most notably PJM — have devised a capacity auction approach that lets them bid for a plant’s capacity for a stated term. “Say you have a 300-MW, gas-fired plant and you bid it in and win. Whatever the capacity charge that you won, grid operators pay you for that, 7/24. The grid operator might narrow the bid to peak or off-peak hours. The operator can slice it any number of ways. But basically, the utility pays to have that plant available for possible power shortages. So really it’s a charge for availability,” he said.
“You don’t see a wind plant in capacity auctions because wind-farm capacity is not dispatchable. It is possible to dispatch a gas plant as long as there is an available supply of gas, and then run it almost 24/7. But wind cannot be dispatched on a schedule because when the wind’s not blowing, a wind farm produces nothing. ” The same thing is true for solar. New markets
Lower cost electric cars such as the Tesla Model 3 could be game changers for the utilities in that they would create more demand for power and reverse the slow growth of the last 9 years.
Twenty to 30 years ago, power forecasters would always predict a higher power price, because demand would be higher. But the demand for power has slowed over the last eight years. Certainly the recession is part of the reason. The economy is not growing as fast as it once was, so the demand for power is not growing. “Also, we have gotten much more efficient. For instance, modern appliances and LED lights are more efficient than the devices they replace. So things of that sort have tended to moderate demand,” Einowski said.
In addition, utilities across the nation have initiated what they call demand-response pricing. That means, in California for instance, you pay more for power to run an air conditioner in mid-afternoon than after midnight. So it’s better to use power more wisely than to build more power plants.
What will happen to demand in the long term? “A big power demand that no one saw 30 years ago was all the electronic gadgets in use today. The millions of smart phones, for instance, collectively draw a lot of power. While we have seen sudden shifts in the economy, I don’t see anything out there that would cause me to think there’s going to be an increase in demand for electricity on average greater than we’ve seen in recent years. Unless we see another real boom economy. But then, who thought that Dick Tracy’s two-way wrist radio would be in every school kid’s backpack in the form of a cell phone — with a computer in it to boot! One never knows.”
EVs are one wildcard. Although they are a small fraction of sales, that could change. Tesla, for example, recently announced more than 500,000 preorders for its Model 3. “As the technology continues to improve, we could easily be in a situation where consumer acceptance turns on a dime. Five years ago, it was difficult to give EVs away but five years from now people might ask others: Why are you buying a gasoline-powered car?”