Saturday, September 25, 2010

Hardscrabble Wind Farm - A Bit of a Mystery

Introduction
Iberdrola (a huge Spanish electricity company which owns NYSEG, Rochester Gas & Electric (RG&E), Scottish Power (UK), Community Wind and who bought up a couple of US Wind developers - Atlantic Renewables, Pacific Power) recently announce the construction of a 74 MW wind farm near Herkimer, NY. This is the first wind farm to be constructed in NY in over 2 years, since electricity prices collapsed in NY in mid-2008. See http://iberdrolarenewables.us/rel_10.08.30.html and http://www.cmellp.com/images/Hardscrabble%20Wind%20Farm.pdf for some more information. Iberdrola has extensive wind power plant holdings in Europe (see http://www.yourrenewablenews.com/iberdrola+renovables+posts+€156+million+first-quarter+profit,+up+37%25_48615.html#1) - such as ~ 5500 MW of wind turbine capacity in Spain and about 3200 MW in the U.S. They own the largest wind farm in Europe (Whitelee, 322 MW --> 539 MW in Scotland) and are planning the biggest European wind farm in Romania, a 1500 MW facility for over E2 billion (more like $US 3 billion). So, when it comes to wind turbines, they tend to know this subject well. Their worldwide revenues were E25 billion in 2009.

Discussion
The wind farm is to be located on a pair of ridges near the tiny town of Norway, NY. In total, there will 37 x 2 MW Gamesa G90 units (90 meter rotor diameters) placed on 100 meter towers. These will be the tallest wind turbine towers in the U.S. (routine for Europe) - most tend to be 80 meter tall towers, but the extra 20 meters will be able to tap stronger winds on average. The turbines will be made in Pennsylvania. The wind farm is expected to produce 200,900 MW-hr/yr, or an average of 22.9 MW, or 619 kw per turbine (average efficiency would be about 31%). The wind farm also happens to be located on the NY City side of the "Utica junction", where several high voltage/high power electricity lines converge/diverge, possibly allowing the wind farm owners to tap into the higher electricity prices that tend to be present in downstate NY.

The wind farm is expected to cost $200 million, or $2.7 million per MW of capacity, or $8.7 million per delivered MW. By most U.S. standards, this is pricey for onshore wind. How does this work, financially and economically speaking? Will the fact that Iberdrola is also a monopoly Grid distributor (though not in the Herkimer area) allow them to roll this higher (than presently depressed electricity prices) priced electricity into their customer mix? What does this do to the NYISO design where electricity producers are separate entities from electricity distributors - the basis for NY's "deregulated" and "competitive" electricity system, which otherwise is presently incapable of installing new wind turbine projects?

Some Answers...
While most people think that the Production Tax Credit (PTC) - now worth $21/MW-hr for the initial 10 year period - is the only or the most important subsidy for wind turbines (and which helps smooth over/equalize with the tremendous subsidies given to nukes and coal/natural gas burners), this is most certainly not true. In fact, the most important subsidy is called the MACRS (rapid depreciation) subsidy. It allows the wind farm project to be depreciated over a 6 year period (71% in the initial three years), and the interest paid on any project debt can also be added to this imaginary loss. However, for both the MACRS and the PTC, the owner(s) needs to have taxable income from some other sources for this legalized tax avoidance (also more kindly called tax income) to be able to be used. The very steady income from the NYSEG and RG&E operations will allow for that to happen.

The exact details of the Herkimer deal are proprietary, so some of this is informed guessing, but it should provide an idea of how this project could be financially viable. Let's assume that Iberdrola finances all of this $200 million project at 7% for 20 years, and thus pays about $80 million in interest in the initial 6 years. Their deductions would then amount to $280 million (project cost plus interest on loans) over the initial 6 years. Since they would pay a 35% Federal tax rate and a 9% NY State tax rate, their combined marginal tax rate would be 44%. Thus, they could avoid payment of close to $123 million in the initial 6 years of the project. Not bad....

The PTC would amount to about $4.2 million/yr for 10 years, or $42 million in tax credits.

The combined MACRS and PTC would be $165 million in taxes not paid (= tax income), which is 82.5% of the project cost. Of course, someone else will eventually have to pay for the taxes not paid by NYSEG/RG&E, but that's not Iberdrola's problem .....

As for the project, let's assume that it is expected to generate a 10% return on investment, of $20 million/yr for 20 years. This means that the sum of all income from avoided taxes and sales of electricity would need to be $20 million/yr, which means that a price of almost 10 c/kw-hr ($100/MW-hr) would be needed. And let's also assume that the cost of all operations, maintenance, taxes, leases, warranties (O&M) would average $15/MW-hr. This wind farm would need 11.5 c/kw-hr to meet these expectations... or $460 million over a 20 year period, or $23 million/yr....

The $165 million in avoided taxes also gets supplemented by sales of Green Tags to NYSERDA (RPS), also worth $4.2 million/yr for the initial 10 years, or $42 million. Thus, the total assured income is $207 million (via avoidance of Federal and State taxes). So, only $253 million over 20 years (or $12.65 million/yr) has to come from electricity sales. This means a price of $62.9/MW-hr (or roughly 6.3 c/kw-hr) has to come from electricity sales.

Of course, for many places, 6.3 c/kw-hr for generated electricity is quite reasonable, but not in NY State in 2010. State average prices for generated power are averaging near 4 c/kw-hr - for example, see http://mis.nyiso.com/public/htm/damlbmp/20100927damlbmp_zone.htm (Herkimer is in Zone E (Mohawk Valley)). And until those prices get back up to more than 6.3 c/kw-hr, this project is not looking so good for the investor, but a bargain for customers. The wind energy generated will tend to displace expensive oil and natural gas sourced electricity, which will further drive prices into the dumpster, again good for consumers, and the pits for investors concerned with earnings expectations and cranky stockholders.

Of course, what if natural gas prices spike, and electricity prices rise above that 6.3 c/kw-hr? Well, there will be no bargain for customers, and big bucks for the investors who took such a gamble on the NYISO Casino. And if some poor people get their electricity cut off in the winter for lack of money to pay the bills (Darwinian Economics), oh well, I guess that will make the ultra-conservatives at the Chicago School of Economics happy campers upon hearing to the evidence of "the invisible hand of the market place" (people dying is not likely to perturb them much at all - see the book "Shock Doctrine" for why that statement rings true). Remember, hypothermia was not an uncommon cause of death in America in 1932. No wonder Herbert Hoover lost that election.... But anyway, we may be heading for a reprise unless some actions are taken to avoid such a calamity...

Of course, if wealthy people and large corporations paid taxes instead of avoiding them, there might be some money in governmental coffers to keep poor people from freezing to death, or from dying of pneumonia brought on by "thermal stress" - living in cold temperatures with a bad diets and little money for health care, decent food or decent housing. And Iberdrola is very familiar with Feed-In Laws - that's where they get huge parts of their revenues from, and why their investments in Europe provide enough stability to go on takeover binges. So, all these subsidies are not needed to get wind investment - and in Iberdrola's case, they would probably welcome a sane fixed price for a long time period, as this would allow them to borrow money at lower interest rates. Odds are, they don't relish the prospect of losing money for several years, waiting for that electricity spike to make the Herkimer project decently profitable.

DB

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