Despite Strong Growth Outlook, U.S. Wind Market Faces Several Risk Factors


Despite Strong Growth Outlook, U.S. Wind Market Faces Several Risk Factors The wind power industry responded in record fashion to the U.S. Internal Revenue Service's (IRS) 2013 ‘under construction’ deadline for production tax credit (PTC) eligibility.

Developers in the U.S. have started construction on 13 GW of wind projects and have contracted 7 GW of firm turbine orders through the end of January 2014. MAKE Consulting estimates nearly 19 GW of wind projects are in active development as a result of these IRS guidelines, demonstrating yet again the tight linkage between U.S. wind market activity and the undulations of PTC policy.

Despite the impressive development numbers, MAKE considers realization of the full 19 GW of development dubious and is forecasting approximately 16.4 GW of grid-connected capacity from 2014 to 2016.

The primary driver behind this demand shortfall is MAKE's estimate of over 7 GW of projects under development that have claimed PTC eligibility without an offtake agreement in place. These projects face the greatest execution risk due to a myriad of factors, including the following:

– More than 5 GW of these at-risk projects are in Texas, where power pricing remains below $30/MWh;

– Aggressive wind development is rapidly consuming additional transmission resources provided by the Competitive Renewable Energy Zone initiative in Texas;

– Minimal load growth in the U.S. is further reducing the need for new power purchase agreements (PPAs) in the near term; and

– There is a lack of alternative project financing options for developers not able to obtain a PPA.

The low cost and scarcity of PPAs has prompted a great deal of attention to alternative finance structures, namely so-called "synthetic PPAs."

These financial hedging instruments provide independent power producers (IPPs) a stable power offtake price while participating as a merchant IPP in regional power markets. IPPs need long-term offtakes from creditworthy counterparties to obtain project finance, however, and there are few large-scale power traders directly engaged in wind hedging products.

JP Morgan is divesting its physical commodities operations, and companies such as Citigroup and Morgan Stanley are already contributing to an estimated 1 GW of "Texas hedge"-type project structures.

Furthermore, these financial instruments are often short term in nature and may not cover the full output of the wind farm, forcing the IPP to maintain some of its capacity in an unhedged merchant arrangement. This introduces a great deal of risk to the wind farm's revenue-generating capabilities and may preclude the developer from obtaining the bank financing it needs to build the project.

MAKE estimates nearly 3 GW of hedged projects will come to fruition during our forecast period, with developers that are unable to obtain a PPA or access alternative finance arrangements being forced to cancel development plans or sell their assets to larger IPPs with greater financial capabilities.

The window of opportunity for these stressed developers will not be open indefinitely. There are developers within the at-risk pool claiming PTC eligibility by demonstrating "continuous efforts" via their search for offtake agreements. This strategy may allow for project construction post-2016, but it runs the risk of an IRS audit and elevates the finance risk of the project.

In order to avoid this audit, IPPs must begin commercial operations by the end of 2015 per IRS guidelines. Industry stakeholders have voiced their concerns on the ability of a diminished U.S. turbine supply chain to cope with yet another compressed build schedule between 2014 and 2015, especially as 92% of the firm and conditional orders volume is concentrated among the Big Three turbine suppliers: GE, Siemens and Vestas.

MAKE does not believe that nacelle production is a limiting factor. However, the mass exodus of many domestic tower original equipment manufacturers (OEMs) from the U.S. wind market, coupled with import duties on towers originating from China and South Korea, has placed a premium on tower supply. Aggressive turbine pricing among the Big Three is likely to abate as those manufacturers approach capacity limits, driving asset owners to source turbine supply from alternate vendors. Â

In this circumstance, lead times for turbine supply may be much longer, as nacelles and blades sourced from the European Union carry much longer lead times (some estimates as long as 10 months).

The concerns associated with obtaining offtake agreements and obtaining turbine supply in a timely manner are driving more attention to a potential extension of the recently expired PTC as part of a tax extenders package this year. The potential for more far-reaching tax reform this year is limited, and as such, a single-year extension is looked upon as a much-needed bridge to longer-term energy policy initiatives such as those sponsored by Sen. Max Baucus, D-Mont.

The Baucus legislation envisions a Clean Energy Tax that seeks to reduce the greenhouse gas (GHG) emissions of the U.S. power generation fleet by 25%, rewarding tax incentives similar to the PTC to technologies on a scale determined by their CO2 emissions. The legislation is in its early stages, and key items such as defining the baseline from which the GHG reductions are measured need to be defined.

In the interim, the extenders package is expected to allow for a one-year extension of both the "under construction" deadline and the "commercial operation date" deadline required to avoid "continuous efforts" at the end of 2015.

Given the current state of development activity and likelihood that approval of the extenders legislation would be later in the year, the emphasis for developers will remain on executing their existing backlog and acquiring distressed project assets. MAKE's baseline forecast does not include a PTC extension.

The U.S. wind market remains healthy despite its current set of challenges. There are nearly 5 GW of new orders required to meet MAKE's current 2014-2016 forecast estimates of 16.4 GW, with additional demand upside in the event of a PTC extension.

PTC-qualified developers with turbine agreements in place are busy with project construction and preparing to execute the second and third phases of those under-construction projects in the 2015-2016 timeframe. PTC-qualified developers in need of offtake agreements will be scrambling to find financing that allows them to partake in the U.S. wind industry's latest bubble.

Luke Lewandowski is research manager and Dan Shreve is partner at MAKE Consulting. Lewandowski can be reached at (312) 441-9590 or Shreve can be reached at (978) 448-3186 or For more on MAKE's latest U.S. market forecast, click here.

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