32 reFOCUS November/December 2004 1471 0846/04 ©2004 Elsevier Ltd. All rights reserved.

Wind Energy

BEYOND THE Renewable EnergySupport in the US

The U.S. government has a history ofsupporting renewable power tech-nologies. This support has taken the

form of publicly funded research and devel-opment activities, to the tune of over $15billion in the past 20 years, as well as directmarket intervention through the enactmentof favourable regulatory policies, such as thePublic Utilities Regulatory Policies Act of1978, and direct tax incentives like theinvestment and production tax credits.Among these support mechanisms, the 10-year inflation-adjusted 1.5 ¢ per kilo-watthour (kWh) production tax credit(PTC) originally available to wind andclosed-loop biomass facilities is generallyviewed as the most effective method forachieving increased market expansion ofrenewable energy sources.

The PTC, which was enacted under theEnergy Policy Act of 1992, originallyexpired on June 30, 1999. This led to a two-and-one-half-year retroactive extension inNovember 1999, which moved the expira-tion date to December 31, 2001. The creditexpired a second time at the end of 2001,but was extended again by the Job Creationand Workers Assistance Act of 2002, whichmoved the expiration date to December 31,2003. The on-again, off-again cycle contin-ued when the PTC expired for the thirdtime on December 31, 2003. U.S. Windcapacity growth stalled in 2004 afterexpanding by nearly 40 percent in 2003.Finally, after a 10-month lapse, on October

4, 2004, President George W. Bush signedthe Working Families Tax Relief Act of2004, which reinstated the PTC throughDecember 31, 2005.

In this year's Renewable Power Outlook,which presents a 12-year forecast of renew-able power generation and capacity based onan underlying market model that assessessupply and demand on a state-level, we proj-ect U.S. wind capacity to expand by nearly2,800 megawatts (MW) through the end of2005 as a result of the PTC recent reinstate-ment. On the surface, this forecast seems tosupport the conventional wisdom that thePTC is a significant driver of wind marketgrowth. However, despite the credit's appar-ent effectiveness over the past several years,both our assessment of the historical pat-terns of U.S wind market growth, and ourexpectations regarding future growth trends,indicate that the PTC may actually inhibitU.S. wind market growth moving forward.

Wind developmentAs illustrated in Figure 1, in the first 5 yearsafter it was originally made available in 1993,the PTC was ineffective in stimulating windmarket growth. During this period, low nat-ural gas prices - as a result of the deregulationof the natural gas industry that began withthe passage of the National Gas Policy Act of1978 and culminated in Federal EnergyRegulatory Commission Order 636 - andutility reluctance to invest in generationassets - as a result of piecemeal state-level

deregulatory processes thatswept through the nation inthe mid-1990 - worked together to create aperiod of dormancy for all renewable powertechnologies including wind, despite thepresence of the PTC.

Investments in wind energy started totake off in 1998 with the construction of142 MW of new capacity, and they pickedup steam in 1999 with the addition of 890MW. Wind energy capacity grew at an aver-age annual rate of 31 percent between 1998and 2003, increasing from 1,600 MW in1998 to 6,300 MW by the end of 2003.Although, at 6,300 MW, wind energy repre-sented just 1 percent of total U.S. capacity,it was the fastest-growing segment of thepower market in 2003 prior to the PTCexpiration at the end of the year, and it hadbecome recognized by power industry par-ticipants as a promising investment oppor-tunity for energy players looking for thenext opportunity in the wake of the gas-fired generation build-out.

RPS and other policiesOur review of the historical record indicatesrenewable portfolio standards (RPS), incombination with other state-level policiessuch as utility specific settlement agreementand Integrated Resource Planning (IRP)processes and increasing gas prices startingin 2000, had more to do with the increase inU.S. wind capacity from 1998 through2003 than the PTC. Wind capacity growthin Texas, Iowa and Minnesota are the directresult of these state-level policies. Even thedevelopment of wind energy in states with-

The much talked about Production Tax Credit (PTC) in the US hasbeen widely regarded as one of the most effective ways forexpanding the installation of renewable energy sources such aswind energy. However, how effective is it really and are thereother alternatives? Brandon Owens, Senior Consultant, PlattsAnalytics reports.

PTC

Author informationBrandon Owens is a senior consultantat Platts Analytics, USA. He can bereached via email atBrandon_Owens@Platts.com

out RPS goals, such as the 162-MWColorado Green project, can be traced to therecommendations of the state regulatorybody. As illustrated in Figure 2, during thisperiod, state policy-driven wind market wasinterrupted only by two PTC lapses.

Looking ahead, the Renewable PowerOutlook projection indicates that 21,500MW of new wind energy installations willbe developed in states with favourablerenewable power policies through 2016.These policies include state tax incentives,RPS mandates, green pricing programs, andsystem benefit charges. Further, given highcurrent and future natural gas prices, weexpect 1,800 MW of new wind capacity to

be developed outside of these states becauseit will be the least-cost generating option.These numbers indicate that over 90 percentof U.S. wind market growth will be drivenby state-level policies. Although the credit iscurrently set to expire at the end of 2005,our forecast assumes that the credit will beextended through 2006 as currently pro-posed by the wind industry.

Role of the PTC?Given the low price of natural gas through2000, we believe that the PTC played animportant role by reducing the cost of state-level policies to an acceptable cost thatallowed state renewable power policies to be

successful without consumer or regulatorypush back. Essentially, the PTC provided amechanism by which federal taxpayers couldsubsidise the renewable power policies of ahandful of states with progressive energypolicies. Moving forward, we believe thatthe role of the PTC will be diminished. Asillustrated in Figure 3, our forecast indicatesthat natural gas prices will average $5.75through the end of the decade. Assumingeven the most optimistic heat rate of 7,000Btu/kWh, the cost of gas-fired generationwill be approximately 4 ¢/kWh (excludingO&M and capital costs). For comparisonpurposes, without the PTC we expect windenergy to cost approximately 4-5 ¢/kWh atpremium locations even in the absence oftechnological progress. This is why webelieve that wind will remain competitivewith conventional generation options overthe next decade and the PTC will thereforeplay a diminished role in guaranteeing thesuccess of state-level policies.

On-again off-againWhile the role of the PTC in supportingstate-level policies will be diminished in ahigh natural gas price environment, the neg-

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Wind Energy

Figure 1. Renewable Energy Capacity Growth Rate (1981-1998)

ative impact of the credit on the wind indus-try will likely increase. First, the on-againoff-again status of the PTC, and uncertaintysurrounding future credit availability, hasboth resulted in periodic stalls in wind mar-ket expansion (see Figure 2) and may beresponsible for the lack of wind market par-ticipation by major energy players, domesticcommercial banks, and passive tax equityinvestors. The entities simply don't want tobother with the U.S. wind energy market ifthey risk having to halt their investmentplans periodically during PTC lapse periods.Political uncertainty is difficult to planaround.

Second, the PTC is a tax credit, whichmeans that renewable project owners musthave a substantial tax bill to take advantageof the credit. This implies that project own-ers must have a substantial 10-year stableincome stream on other projects that can beused to offset the tax losses created by theavailability of the PTC. This is not the case

for any but the largest project developmententities. In addition, the PTC is difficult forindividuals, S corporations, and small,closely held C corporations to use. That'sbecause the credits are subject to passive lossrules that limit these types of taxpayers tousing the credit solely to offset income fromother passive investments. To avoid thisproblem, the taxpayer must be involvedpersonally in the day-to-day operation ofthe project. The passive-loss rules do notapply to larger corporations. Even withalternative project structures such as limitedliability partnerships, tax appetite limita-tions and passive-loss rules have severelyconstrained the equity market for windprojects.

Constrained marketBecause of these limitations, very few enti-ties have invested equity in the U.S. windmarket today. There are approximately onedozen equity participants active in the wind

market today that have demonstrated a will-ingness to take an equity position in a windproject. In the constrained market causedby the PTC rules, equity players can exer-cise their market power by requiring higherrates of return and a lower level of risk for their equity capital. In at least two casesin 2003 exorbitant equity terms made sev-eral projects incapable of being financedeven though these projects had power purchase agreements with creditworthycounterparties.

The net result of the current PTC struc-ture has been a monopolization of the windmarket by U.S. firms that have the taxappetite required to utilize the credit, to thedetriment of smaller wind developers whoare-in some cases-locked out of the market.One can only speculate that this type of mar-ket distortion was not the original intent ofthe credit. We postulate that U.S. windcapacity would expand at a significantlyfaster rate than under the current incentiveregime. Because of these restrictions, webelieve that wind market growth will befaster if the PTC is allowed to permanentlyexpire at the end of 2006. Another round ofpolitical bartering leading to a reinstatementof the PTC sometime in 2007 is likely tocause severe long-term damage to the U.S.wind industry. Instead of adding 4,000 MWin 2007 as we expect, capacity expansionwould stall again and some wind industryparticipants may permanently opt out of amarket that is driven more by Washingtonpolitics rather than by underlying technolo-gy economics.

FutureThe solution is to either seek a permanentPTC extension, with the addition clause thatallows the credit to be transferred or refund-ed, or to develop an alternative policy ofequivalent value to the wind industry with-out the limitations of the credit. Given theeconomic attractiveness of wind powertoday, we believe that the successful imple-mentation of either of these policies wouldput the U.S. wind industry on track for rapiduninterrupted growth over the next twodecades. Indeed, as reflected in ourRenewable Power Outlook forecast, we believethat the U.S. wind energy portfolio will growto 30,000 MW by 2015 in a stable policyenvironment.

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Wind Energy

Figure 3. Henry Hub Price Forecast and the Marginal Cost of Gas-Fired Generation (2004-2010)

Figure 2. U.S. Renewable Energy Growth (1998-2003)