Wind Energy: A Mature Business Challenging Fossil Generation Profits

Wind energy is a rapidly growing and profitable business worldwide, usually at the expense of fossil fuel generation revenue and, more importantly, profits. Unwrapping the conditions underlying profitable wind farms is useful when considering getting into the wind energy business or analyzing it, but also in terms of understanding motivations and tactics of those opposed to wind energy.

The factors determining the profitability of wind energy projects are the wind resources available, modern wind turbines, an effective economic regime to sell wind energy into, relatively cheap connections to the grid, highly optimized management and maintenance, and efficiency in getting to operational status.

 Source: Utility-Scale Land-Based 80-Meter Wind Maps

Source: Utility-Scale Land-Based 80-Meter Wind Maps

 

Wind Resources

A large factor in the amount of energy a wind farm can generate is how regularly and steadily strong winds blow at the site. Brazil and the USA are seeing 50%+ capacity factors in some of their wind farms due to the strong and ceaseless winds that they experience. King Island in Tasmania, if the feasibility study currently under way bears fruit, will be in a similar position.

This is a reason why offshore wind farms make economic sense despite higher initial and operating costs: the wind is stronger and steadier out to sea than onshore due to fewer obstacles creating near surface turbulence and disrupting the laminar flow of the wind. This is also why ridgelines are often favored for siting wind farms. The geographical feature at 90 degrees to the prevailing winds causes compression and speeds up the wind, pushing more energy through a smaller area, as well as elevating turbines above numerous sources of turbulence.

Less turbulent and faster moving air means there there is more energy more of the time for wind turbines to extract.

Source: Wind Resource Assesment and Met Tower Installation by Anemometry Specialists

Wind resources are a serious business with significant data analytics behind them. The best wind resource spots are identified first by meteorological historical and predictive models, then assessed by putting up wind sampling towers that validate and refine local conditions. The reason this is important is that most meteorological models operate on 30x30 kilometer grids or larger, and a wind turbine and farm sits in a particular part of one square.

Modern wind turbines are tuned for specific ranges of wind energy. Differences in blade widths, pitches and profiles, along with differences in gear boxes and other internals, allow modern wind turbines to be much more productive at taking energy out of lower wind energy resources. What this means is explored more in the next section.

Modern Wind Turbines

Wind turbine technology has changed dramatically in the past twenty years. Where a 600 kW faceplate capacity wind turbine of twenty years ago might have a 20-25% capacity factor, a modern 3 MW faceplate capacity wind turbine might have a 40% capacity factor in reasonably good wind resource locations and 47%+ in the best wind resource locations.

There have been strong and ongoing incremental innovations in the iconic three-bladed wind turbine over the past sixty years including increasing height, more aerodynamic blades, bigger blades, variable pitch blades, gearbox improvements, coatings and more which have consistently reduced price per MW while increasing availability and capacity factor. Alternative forms of wind generation have all fallen by the wayside, with hedging bets in research into vertical axis, airborne and ducted turbines all failing to come to fruition as productive alternatives.

Doing some math and assuming about 7 cents a kilowatt hour wholesale price, that means a 20 year old wind turbine might receive about $91K revenue annually, while a modern wind turbine might receive about $735K revenue annually. Put 30 of them up and the wind farm comparative annual revenue is $2.8 million vs $22 million.

To the last point in the previous section, wind turbines that are tuned to be most productive at the average wind velocities that modeling and assessment will be more productive and profitable. Many lower wind resource sites are now much more productive than the highest wind resource sites that were used for siting earlier in the development of the wind industry. That's the major reason why wind turbines statistically are being replaced years earlier than their projected 20 year lifespans by the way; it's economically beneficial to replace older wind turbines in good wind resource areas with much more effective modern wind turbines. For an interesting read, check out Vesta's low wind energy efforts in China: Vestas continues to deliver solutions to very low wind speed sites in China.

Modern wind turbines are, of course, more expensive than used wind turbines, and as pointed out, used wind turbines are being taken out of the best wind resource sites. This means that in many cases it can be economically viable to buy old used wind turbines, put them up in a lower or untapped wind resource area and get many more years life out of them with a much lower capital outlay.

Effective Economic Regimes

Most jurisdictions around the world recognize that fossil fuel generation of electricity is heavily polluting, emits CO2e that causes global warming and doesn't have strong social license. As a result, a wide variety of incentive programs have been put in place to shift the generation equation from legacy forms of generation to renewables including wind energy. Programs include the currently lapsed Production Tax Credit in the USA (roughly 2.3 cents per KWH of tax breaks for renewables), the Feed in Tariff (FIT) Program in Ontario (guaranteed higher wholesale rates for renewable electricity for twenty years), the Renewable Energy Target (RET) in Australia (penalties for utilities who do not purchase specific percentages of renewable energy annually) and more.

These plans are designed to level playing fields currently tilted in favour of fossil fuel generation either due to direct incentives to those industries, unpriced negative externalities from fossil fuel generation or both. Recent analysis in the USA showed, for example, that the PTC almost directly offset a conservative carbon cost for natural gas, making the wholesale price of electricity of wind and natural gas almost identical.

Understanding the incentives plan, the likelihood of it continuing and the fine print associated with it can make the difference between marginal or unreliable profitability for a wind farm and rock solid returns. This is familiar to every CFO engaged in any type of business, as there are grants, tax credits and incentives which cover a very wide range of industry in most countries. The likelihood of continuance of the plan is critical to engaging financing for capital intensive wind energy project, as evidenced by the pattern of starts and stops in the USA as the PTC is threatened with or actually allowed to lapse annually.

A second major factor, and a poorly understood one by many commenters on wind energy, is the merit order effect. Most jurisdictions have a regulated market for wholesale electricity. One of the aspects of this market is that the cheapest bid for wholesale electricity requirements at any given time sets the price for all sellers of electricity. As wind energy has very low operating costs, and per earlier statements has favorable economic conditions such that fossil generation will be replaced by wind, the economics typically allow wind energy to set the merit price far more often than competitors that have to pay for the coal or gas that they consume. As wind energy is profitable at that price point, typically all wind energy gets purchased, all else being equal, but fossil generation units ramp down and end up with lower annual capacity factors and at a reduced price for their electricity as well. (Incidentally, this is why no corporation with major thermal coal units in their fleet is touting the profitability of that segment of their assets; they aren't very profitable, and annual revenue is declining as well.) 

Source: Energy to the masses…

A corollary of the merit order effect is that wind energy is driving down the wholesale price of electricity where regulated markets are aligned to it. This is happening in Germany, the United States, Ireland and Australia. While this is generally beneficial, it is disruptive and will lead to changes in how generation is owned and operated in many jurisdictions, as Craig Morris has been writing about for several years.

Ontario, Canada, as a conspicuous example, does not have a regulated market, so the merit order effect does not apply. As a partial result of having a directly managed generation supply by a governmental organization subject to political interference, wind generation is now being curtailed in situations of surplus baseload generation caused by Ontario's excessively large nuclear fleet. As a result, wind farms are being paid a nominal fee to not generate rather than the full rates for the electricity that they provide, with obvious impacts on their revenue streams. Ontario is, however, the first jurisdiction world wide to eliminate coal generation from its mix entirely, with all of the resultant health and environmental benefits that entails.

Relatively cheap grid connections

Electricity is transmitted long distances over 250 kV transmission lines, distributed across broader areas on 100 kV distribution lines and goes the last distance to transformers near homes and businesses on 25 kV local distribution micro-grids. Smaller wind farms and wind farms in more densely populated areas typically feed into the 100 kV distribution grid. Major wind farms such as those in the midwestern USA typically feed into the long distance 250 kV transmission lines.

Connection to the grid, its associated wires, poles, transformers and SCADA-devices costs money. How much money and who pays for it are critical factors in a business case, as there is capital and operating outlay for it.

The first big factor is merely being close to existing lines. Putting up a wind farm near existing lines means that it's much cheaper to attach the wind farm to them.  Most onshore wind farms are built nearer to people rather than further from them; the 100 kV distribution lines are cheaper to connect to and are also closer to end users.

The second big factor is who pays for installation and maintenance of lines and connections. As utilities that maintain the lines usually do not own the wind farms, and as the utilities are typically regulated and charged with maintaining stability of the lines, and as most jurisdictions sensibly want more renewables to supplant fossil fuels, most jurisdictions have required utilities to pick up the cost and effort, and to prioritize the work appropriately. However, that's not true everywhere, and utilities often don't have the resources to build connections as fast as required.

There is a hidden factor in the above issue of grid connections: utilities often don't have sufficient resources or don't prioritize them to get renewables connected as rapidly as they can be built. Delays in connectedness mean delays in revenue, which means delays in achieving profitability while continuing to incur financing and operational costs. This has been problematic in Ontario and is a significant inhibitor in China and India at present. Often wind resource is distinct from population as well. In the USA, the Midwest has the best onshore wind resource, but the less dense populations and transmission line upgrades needed to enable shipping more power back to the east coast will be costly and a challenging set of projects into themselves.

Optimized Management and Operations

This has been a relatively poorly explored area over the past several decades, with most wind farms choosing to opt for expensive and sometimes sub-optimal maintenance contracts with the wind turbine manufacturers. This is changing rapidly at present because so many other portions of the supply chain and cost structures have been refined to a highly optimized state, so this relatively smaller area is now undergoing scrutiny.

Asset management and analytics software is being applied to the wind industry, with typical results of more efficient and lower cost maintenance regimes and operations cycles.

This last is low-hanging fruit for existing wind farms that are being acquired and consolidated under larger companies at present. These companies are bringing better and cheaper practices that they can afford across their fleet, where individual wind farm operators don't have critical mass for the optimization costs.

Efficiency in getting to operational status

There is significant upfront investment required in preparing for and delivering a wind farm to operational status. Wind assessments must be performed over one to two years. Leases must be established early with potential host landowners to lock up the resource. Connection to the grid must be established. Environmental and land use planning submissions are required, along with appeals and hearings related to them. The wind turbines themselves are the major expenditure, and selecting and acquiring them from a global supply chain is a very large piece requiring dedicated expertise by itself.

Each of these has significant opportunities for waste and delays, and at a certain point capital expenditures on the wind turbines must be committed to and contracted regardless of whether the remainder of the process is complete. This incurs significant operating costs in debt financing prior to any revenue.

Delivering wind turbine components to wind farm sites is a major logistical undertaking in and of itself requiring middle men, major transportation firms and multiple modes of transportation. Each of these requires careful management of expenses. Construction is relatively straightforward by comparison, as is operational testing, but these too take time.

These various processes mean that that a major wind farm is typically several years in the planning and preparation before operation, and incurs it's capital costs well before any revenue occurs.

Driving these processes with focus and effectively to reduce the time to operational status has direct implications for ROI.

Which of these factors create opposition?

At the first level of analysis, most developed countries such as the USA (see figure) are not experiencing any increase in electricity demand, in fact some such as Australia and Ontario are seeing a decline as efficiency measures kick in on top of well established flight of industry to cheaper labour markets.

US electricity demand year-over-year

This flat demand is occurring at the same time that wind energy is increasingly competitive, many generation assets are coming to end-of-life or the point in their operational lives when major and often expensive upgrades are required and wind energy can guarantee rates and stability for decades due to the lack of volatile fuel costs. As a result, jurisdictions around the world are often opting to build wind farms instead of upgrading or replacing fossil fuel generation plants for strictly strategic generation diversity and long-term price stability reasons.

The merit order effect plays into this already lower demand market where fossil fuel generation assets expected to produce additional profits are being mothballed by lowering the peak pool price of electricity. Many fossil fuel generation assets are only profitable due to the historically high pool price during peak demand periods, and some such as peaker gas plants have 10% capacity factors simply because they are only operational during peak periods. With wind energy increasingly setting the wholesale pool price at a much lower point than historical rates, many fossil fuel assets are no longer profitable or are now at such low levels of profitability that owners are considering ways to extract themselves.

So far we have an already potent two-pronged attack on profitability of major fossil fuel generation organizations. Deferring or reducing the impacts of these two factors alone is worth billions, hence the well-documented expenditures by fossil fuel generation and supply organizations to front groups and lobbying organizations seeking to combat them. Basically, they are buggy whip manufacturers facing Henry Ford's high-efficiency automotive assembly line and they are trying to delay the inevitable as long as possible.

Incentives such as the Production Tax Credit (PTC), Feed-in Tariffs and Renewable Energy Targets (RET) are where the challenges compound further. On the one hand, these disruptive technologies are already displacing fossil fuel generation in a low demand growth market, but then governments put in place policies to accelerate deployment of wind and other renewables further due to well-understood societal costs of burning coal and gas. While fossil generation interests have historically benefited from significant incentives in different markets, most fossil fuel generation interests simply don't have the competitive skills and ability to deal on a level playing field where their product is so clearly inferior.

In countries such as Australia and the USA, this also ties into an ideology of absolutely free markets and unfettered capitalism as the best mechanism to achieve all ends. In that mindset, any market distortions subvert the effectiveness of the marketplace and as such are demonized without requiring further analysis.

The intersection of fossil fuels and this ideology are nowhere more apparent than in the Koch Brothers of the USA, who inherited a fossil fuel fortune from their father and have spent most of their business lives preserving and extending it. They promote, through organizations such as the Heartland Institute, a potent mythology of self-made titans of industry being stymied by big government, and fund global warming denialism and fact-deprived attacks on renewables. 

The alignment of loss of profitability with ideology is fascinating, and highly explanatory of attacks on wind energy and other renewables from many fossil fuel organizations.

Which of these factors are key in tactics used to oppose wind energy?

Promotion of the ideology of free markets and attacks on big government and regulation are a core tactic in attacks on renewables. Ongoing efforts to kill the PTC in the USA, the carbon tax and RET in Australia and the FIT in Ontario are well-documented and regurgitated endlessly in anti-wind advocacy press and forums. From an objective perspective, it's obvious that minor incentives to overcome organizational inertia and hasten the shift of electrical generation to pollution-free and carbon-neutral sources is of high value to governments and economies in general. Leaving it to the market simply will simply result in greater degradation of the environment with further offloading of health costs from corporations that degrade the environment.

The variability of wind is an easy target. If there were no history of wind energy at all, a mediocre public relations agent would undoubtedly hit on this characteristic as the first point of attack, simply because everyone has experience of periods when the wind doesn't blow. That this is relatively immaterial in terms of interconnected grids and wind generation assets tuned to wind resources is a sophisticated counter-argument without the emotive force. That there are 300,000 utility scale wind turbines with a faceplate capacity of 300 GW operating in early 2014 worldwide is a strong but indirect argument for the obvious value of the source of energy as well. 

As these are countered, the maintenance and reliability of wind turbines is increasingly being challenged and this will likely increase. Numerous cherry-picking statistical analyses and anecdotes circulate about wind turbines failing early, or having shorter lifespans than projected or having failing gearboxes. Many sources point out that modern wind turbines have availability factors of 98%, i.e. an expected downtime due to maintenance of 2% of the total time in a year. This is not disproportionate at all, as relatively modern and well-maintained nuclear plants typically have 90% availability factors. Once again, it's easy to put up a picture of a single wind turbine that is broken or not working when there's wind and claim a problem, and a harder argument to point out the statistics that underly reality.

Grid connections and long-range transmission often come under attack as well, with organizations claiming destabilization of local grids, or that the high cost of long-range transmission connecting different parts of countries and into other jurisdictions is overly costly, when in fact research shows it is almost always beneficial in terms of price reduction through increased competition and deferred local generation buildout.

Summary

Access to a good resource in a favorable market, incented for growth, incremental innovation, and solid management are conditions which have been the basis for innumerable successful business models, from fossil fuels to trains to consumer electronics. The wind energy business continues to have double-digit growth worldwide because of these fundamentals. It's upsetting the status quo because that's what disruptively innovative businesses do, and the status quo is resisting because that's what the status quo does. Conflict is inevitable, but understanding it allows effective management of it.

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published this page in Wind 2014-04-04 07:03:43 -0700
published this page in Wind 2014-04-02 12:39:24 -0700