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The Year Ahead For US Wind

by: Charles Morand August 08, 2008 | about stocks: AMSC / FAN / FPL / GE / PWND    

Charles Morand

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Even though solar, and especially solar PV, has managed to capture the lion's share of public equity investors' attention over the past three years, wind remains far more competitive with with fossil-fired power generation on a cost basis than solar, and thus presents a fundamentally stronger investment case for the time being (and I emphasize for the time being). What's more, wind as an industry is more mature than solar; for solar, the lack of earnings for many companies and the wildly inflated PEs for others make the sector potentially volatile and risky for investors.

While installing a kW of commercial wind in 2007 in the US would have cost you on average $2,200 according to the DOE's EERE (PDF document), installing the same amount of commercial solar PV would have set you back more than twice that amount. In 2007, the cumulative-capacity-weighted-average wind power price (the amount wind farm owners were paid for their electricity on average) was below the nationwide price band for a flat block of wholesale power.

It is therefore not a surprise that, for 2007, the US installed 27% of all global wind (5,329 MW), 62% more than number two China. In fact, between 2004 and 2007, US wind installations were on a tear with a CAGR of 35%, making the US the number one global wind hot spot for that period.

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As can be noted from the graph above (the y-axis is MW), the steepening of the curve has corresponded with a period of uninterrupted Production Tax Credit [PTC] availability. The PTC is a federal incentive for wind power that comes in the form of a tax break per kWh of electricity produced, and has historically been responsible for driving growth in the industry. In fact, the past cycle of PTC expirations and renewals led to a boom-and-bust cycle in US wind, as can be seen from the graph for the period 1999 to 2004.

Is PTC The Whole Story?

The PTC is set to expire again at the end of 2008 for the first time since October 2004, and the Senate currently appears to be in no mood for an early renewal. Needless to say, this is causing headaches in some quarters. Throw on top of that an inflationary environment for power plant capital costs and a credit crisis that's raising the cost of capital, and you've got something like a perfect storm brewing for US wind in 2009. Could the party be about to go on hold?

Not so fast. Another phenomenon has been impacting the US wind sector over the past four years that can undoubtedly explain some of the growth: an explosion in state Renewable Portfolio Standards [RPSs]. RPSs are state targets for renewable power that are made into legal obligations and often include a penalty for non-compliance - the stick instead of the carrot.

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As can be seen from this table, about 58% of US states currently have a formal RPS, and another 8% have a target. Of those, 76% have either enacted or amended (generally to increase it) their RPS or target on or after 2004. The result is that 63% of US installed capacity now sits in a state with an RPS or target, as does 71% of the population.

What Has Really Been Driving Growth?

While keeping the PTC alive all this time certainly accounted for much of the growth since 2004, the proliferation of RPSs cannot be ignored. RPSs enshrine renewable energy targets into law, thereby providing powerful drivers for growth.

Want to know how powerful? You can try come up with your own rough estimate for any state you're interested in. Take the EIA's most recent statistics on installed generation capacity by state (the most recent available year is 2006), grow the state's installed capacity at a rate you find reasonable (e.g. 2% annually or or use an existing forecast if you can find a good one) until the final year of the RPS, and simply apply the RPS target - which is typically expressed as percentage of total installed capacity by a target year - to your final figure. Multiply that amount by a safety margin of something like 0.7 just to be conservative, subtract what's already installed, and you may have a rough idea of how much incremental wind a state will install by its RPS' deadline. Of course, certain states will favor solar for physical reasons, while others have technology targets (e.g. NJ wants 2.5% of solar as part of its 22.5% 2021 RPS). It's up to you to dig a bit deeper to ascertain the particularities of each RPS and what they mean for wind.

I conducted such an analysis for all US states, and while I won't share my numbers because they are very rough estimates and I don't want them quoted, I can nonetheless say that some states will experience very solid growth over the next few years. One example is NY, which will install several thousand MW of wind between now and 2015 although it barely registers right now.

What's the takeaway from all this? There was a time during which the PTC drove the vast majority of wind development in the US, and if it went so did the industry. But over the past four years a growing number of states have adopted formal renewable power targets in the form of RPSs, and those will play an increasingly larger role in fostering growth, especially as wind becomes competitive without the PTC.

The Year Ahead

2009 could indeed be a bit rough for wind if the PTC isn't renewed prior to Dec. 31, 2008. Financing costs could become an issue in the midst of ongoing problems in capital markets, so no PTC could compound this. I don't think, however, that a short-lived slowdown would be a bad thing for the industry. The wind supply chain remains as tight as ever, and a slowing of demand while new manufacturing capacity continues to be added across the US could set the stage for a resumption of strong growth in 2010.

In fact, the current up tick in construction of wind manufacturing facilities in many parts of the US can probably be attributed to the proliferation of state RPSs, and is the strongest indicator yet that the industry sees a life for itself beyond the PTC.

Wind For US Investors

One of the main complaints US investors have with regards to wind is the lack of wind plays available on US exchanges. Like the industry's dependence on the PTC, this, too, is changing.

For one thing, two new wind ETFs have launched in the past few weeks: the First Trust ISE Global Wind Energy Index Fund (FAN) and the PowerShares Global Wind Energy Portfolio (PWND). ETFs are a good way to access a broad basket of pure-play stocks, and thus provide both focused exposure and some risk mitigation through diversification.

Moreover, a quick look through our site's Stocks page will yield several potential picks. A majority of Pink Sheets-listed stocks you will find there under the category Wind are stocks of global wind pure-plays with legitimate listings on exchanges in their home countries (mostly in Europe).

In the US, GE (GE) retains the largest market share for wind turbines (although competition is stiffening to be sure), and GE Energy Financial Services is active in wind park ownership. FPL (FPL), through its FPL Energy unit, is the second largest wind park owner in the world and another way to get exposure to US wind. In both cases, however, it also means you have to buy the rest of the business, which may or may not be of interest.

On the more speculative side, investor favorite American Superconductor (AMSC) remains a play of choice for many, although valuation is a definite concern for me. Although top line has been expanding rapidly on the back of strong growth in China, I feel much of the stock's potential is already priced in.

My favorite way to play this would therefore be thorough one of the two ETFs, although I haven't looked at them in enough detail yet to say which I prefer (this is something I intend to write about soon).

Keep an eye out for what is happening on the PTC front, and for signs that the ETFs' prices are trending down as a result. When to pull the trigger is up to you, but based on what I wrote above you can rest assured that, PTC or not, US wind will continue to exhibit strong growth in the decade ahead, and the prices of stocks should follow earnings on the way up.

DISCLOSURE: The author does have not a position in any of the securities discussed in this article.

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This article has 20 comments:

  •  
    Aug 08 10:10 AM
    Wind is cheaper than solar as of this moment, but not by much. As you mentioned a 1MW turbine costs about $2 million or $2/watt. FSLR's systems are $4/watt installed. However, wind has very high maintenance costs. About 1 in 10 turbines you see in Europe will be non operational. Also, wind generates most of it's energy late night and early morning. Electricity is less valuable off-peak. Solar obviously generates it's electricity during peak hours when it's the most valuable. The main reason investors prefer solar though is the often quoted fact that module prices have fallen 7% a year for the last 40 years on average. Wind turbine prices have barely budged. This is why most expect solar to be the primary alternative energy source in 20 years time.

    Additionally, the only predictable wind plays at the moment are the turbine manufacturers such as Vestas and Gamesas who are not traded on US exchanges. A carbon fiber manufacturer such as Zoltek is no more a wind play that a polysilicon producer such as MEMC is a solar play. AMSC is a small cap with no earnings. This week's price movement shows you the risks involved with these stocks. FSLR, which I have owned for 18 months, has never dropped double digits in a single day despite how overvalued many people claim it to be.
    Reply
  •  
    Aug 08 10:20 AM
    Any thoughts on wind farm operators such as Western Wind (WNDEF.PK)? They reported a profit for the first time yesterday. Albeit, it's a bit deceiving since it was a 10 cent per share profit and roughly 10 cents could be attributed to income from discontinued operations, but all the same, breaking-even doesn't seem so bad for the moment.
    Reply
  •  
    Aug 08 10:35 AM
    Andrew, I'm not sure I buy into the assertion that investors have preferred solar over wind. Just take a look at Vestas and American Superconductor (AMSC). I think it's more likely that, as you yourself pointed out, there simply aren't that many wind pure plays that are available to the average investor. You either have to buy on a foreign market or OTC. In general, investors have shown a preference towards wind turbine and solar module manufacturers when all other things are equal.

    I'm also not sure that the time of day of energy production is the most important consideration UNLESS one were promoting using wind or solar for 100% of our energy generation. In reality, if 20% of our energy production came from either, that would be fantastic! Regardless, we're going to have to rely on other sources of energy (whether it be coal, nuclear, natural gas, or geothermal) on top of wind and solar.
    Reply
  •  
    Aug 08 10:58 AM
    Andrew:

    I disagree with you that "most expect solar to be the primary alternative energy source in 20 years time." On what basis is that anyways? Total MW installed? In 20 years, the total amount of MW of solar installed globally won't come close to that of wind. In some areas, solar will surely predominate, while in others it will be wind. In the US Midwest, Northwest, Northeast and Texas, as well as across Canada, it will be wind. Sounds like the kind of market I could put some money behind.

    The prices of wind installations have actually been increasing, not because the industry has ceased making technological improvements but because wind is impacted to a much greater degree by an inflationary environment for a number of critical components like steel, copper, cement, etc. than is solar. The wind supply chain is very tight at the moment, allowing manufacturers to pass on cost increases and some...

    Wind turbine sizes have been increasing steadily over the past few years, as has the average size of wind parks. Once inflationary pressures settle (which, BTW, are affecting other forms of power generation), the cost of wind will resume it's downward trend. The average size of a commercial solar PV park doesn't even come close to that of wind, and the solar industry remains completely fragmented and in the midst of a technological race.

    While solar does hold great promises, it is for the time being a far more volatile and risky sector than wind is because, by and large, valuations aren't underpinned by earnings. When they are, PEs are through the roof, and history shows that wildly above-average PEs can only be maintained for so long.

    BTW, in the world of power generation, a 100% cost difference is considered pretty significant, so claiming that "wind is cheaper than solar...but not by much" isn't a true statement.


    On Aug 08 10:10 AM Andrew Ling wrote:

    > Wind is cheaper than solar as of this moment, but not by much. As
    > you mentioned a 1MW turbine costs about $2 million or $2/watt. FSLR's
    > systems are $4/watt installed. However, wind has very high maintenance
    > costs. About 1 in 10 turbines you see in Europe will be non operational.
    > Also, wind generates most of it's energy late night and early morning.
    > Electricity is less valuable off-peak. Solar obviously generates
    > it's electricity during peak hours when it's the most valuable.
    > The main reason investors prefer solar though is the often quoted
    > fact that module prices have fallen 7% a year for the last 40 years
    > on average. Wind turbine prices have barely budged. This is why
    > most expect solar to be the primary alternative energy source in
    > 20 years time.
    >
    > Additionally, the only predictable wind plays at the moment are the
    > turbine manufacturers such as Vestas and Gamesas who are not traded
    > on US exchanges. A carbon fiber manufacturer such as Zoltek is no
    > more a wind play that a polysilicon producer such as MEMC is a solar
    > play. AMSC is a small cap with no earnings. This week's price movement
    > shows you the risks involved with these stocks. FSLR, which I have
    > owned for 18 months, has never dropped double digits in a single
    > day despite how overvalued many people claim it to be.
    Reply
  •  
    Aug 08 01:06 PM
    The main benefit of wind power to a large corporation is NOT in the paltry, low quality, electricity, or the raw PTC 1.5c / kwh, which is connected to production, but rather in the luxurious tax breaks that you get. I think that these tax breaks will go the way of the dodo when government income drops like a stone in 2008/9.

    From an investment point of view, wind is only about government tax breaks. I for one would not put a dime this kind of endeavor, given the fickle nature of our politicians.

    "During a December 15, 2004, teleconference, Ed Feo - Milbank Tweed Hadley & McCloy, LLP pointed out that 2/3 of the economic value of wind projects come
    from tax breaks.9
    "
    FPL group paid no federal tax in 2002 and 2003, with 2 billion in net income. When governments come up 10 - 20% short on revenue next year it will be hard to continue these subsidies.

    See:
    johnrsweet.com/Persona...
    Reply
  •  
    Aug 08 01:39 PM
    I would short anything/everything wind energy because it is facing an unforeseen headwind (pun intended). Highly regarded academics will reveal some very disturbing research findings in the near future. Let me put it to you like this. Every environmental organization will come after wind with a vengeance and it won't have anything to do with birds hitting the blades...
    Reply
  •  
    Aug 08 01:46 PM
    Nothing more credible than cryptic comments posted by anonymous sources.
    Reply
  •  
    Aug 08 01:54 PM
    @ Jake

    "Nothing more credible than cryptic comments posted by anonymous sources."

    It's not my fault that my sources/resources are better than yours. Good luck with that portfolio friend.
    Reply
  •  
    Aug 08 01:59 PM
    If you have such great knowledge of the situation, why don't you enlighten the rest of us fools rather than making cryptic comments?
    Reply
  •  
    Aug 08 02:21 PM
    One other thing to help you. Consider CFD (computational fluid dynamics) and climatological modeling.
    Reply
  •  
    Aug 08 02:39 PM
    So in other words, you are incapable of explaining this phenomenon yourself. You are merely relying on your 'better sources' for your information. And in all likelihood, "better sources" = unsubstantiated rumors
    Reply
  •  
    Aug 08 02:47 PM
    @ Jake. You are the one saying I can't explain this phenomena. I'm saying I won't explain it to you.

    It isn't my job/plan/duty to lay every thing out for you. I'm just giving a tip and a wink, and if that is not up to your rigorous due diligence maxima -- then ignore it.
    Reply
  •  
    Aug 08 03:19 PM
    knobsturner:

    You are missing the point. The incentive matters a lot less than it used to - state governments are mandating that renewable power targets be met by utilities. Incentive or not, the RPS will have to be met, which will create demand for wind.

    With regards to the figures you cite in your comment, which date back to 2004, I would urge you to read the document from the DOE I linked to in my article - it contains ample information on wind power pricing from a very credible source.

    The situation is not as you describe it, and while removing the PTC (which is the tax break BTW) would undoutedly raise the levelized cost of wind power, wind would still remain competitve in many parts of the US with wholesale power prices, as evidenced by the fact that a growing number of wind parks are opting to sell a growing percentage of their wind power on a merchant basis.

    But at the end of the day this point is moot, since Congress will renew the PTC at some point between now and the end of 2009.



    Reply
  •  
    Aug 08 05:02 PM
    perhaps 24 is saying if you make lots of windfarms the surface roughness of the earth will increase, negatively affecting the weather
    Reply
  •  
    Aug 08 08:42 PM
    What's the best way to count future wind mills? Answer: just count the back log Trinity Industry (TRN) has. TRN is the largest wind tower builder with over $1.2 Billion back ordered, and rising every day. TRN took over the abandoned massive Maytag plant in Texas to build them, just before T. Boone Pitkens announced his mega Wind Farm plans for Texas. Hmm, something the author forgot to mention, TRN is highly profitable too and is has 40% of the Rail Car market with a massive Rail car back log 3 to 4 times larger then the wind tower business, if I am not mistaken.
    Reply
  •  
    Aug 09 08:13 AM
    Great article. I wasn't aware of the state RPS side of the story.

    Regarding solar, although the price has been coming down due to improved tech and efficiency, there's also a silicon shortage. Late in 2007, all the solar's were trying to lock in contracts for silicon supplies (competing with chip manufacturers to boot). Solar companies like TSL that couldn't lock in and had to pay spot prices suffered during the time. Even with expanding production, I can't imagine this silicon shortage has been completely alleviated. I don't see prices on solar dropping too dramatically for a while unless someone comes up with a serious breakthrough in the tech or the production. And solar is also heavily subsidized, which is fueling its growth (especially in Europe). In CT where I live, I've looked into a solar system for my roof. Out of of $25K cost, I'd get a federal tax credit of $2K and CT would pick up $13K. But its still not worth it based on expected electricity costs. I'm looking at 15-20 years to recoup, paying cash without financing. Wind is here and now, whereas solar is still in the "iffy" stages. I can't see a utility voluntarily installing solar if they can do wind cheaper and meet their alt energy requirements.

    I can see now why T. Boone is suddenly all over the press. I'm sure he knew the PTC was expiring soon and he's putting public pressure to renew it.

    Regarding alpha24seven's "ominous predictions" (I shouldn't even respond but I will), it sounds like he's talking about a ton of windfarms in the Midwest interfering with the Jet Stream. Maybe its time to invest in a ski resort in Florida and a beach resort in Michigan.
    Reply
  •  
    Aug 09 11:32 AM
    there's a lot of wind right here.too bad it cant be harnessed for energy.
    Reply
  •  
    Aug 09 03:34 PM
    I wonder if alpha might have some links on this "Bernoulli Effect"
    as i trelates to wind power etc. Looks interesting , but dont seem to see why its a killer for wind
    Reply
  •  
    Aug 10 10:58 AM
    The implication is that wind turbines cause local climate change, including changes in rain patterns. Duh. I don't need a hint to figure that out. If you think the media won't bury it if they are told to you're goofy. Rich people are getting paid from the government on wind and it won't stop until the next program is unveiled for the elect. It's all about tax breaks. Until there is a fair tax (NOT the FairTax) rich people will get all the breaks and regular people will pay for them.
    Reply
  •  
    Aug 12 03:57 PM
    80,000 wind turbines spread across the midwestern wind belt will have effects on the climate. But those effects pale in comparison to the effects of farming, coal burning, and the myriad of other effects of us 6.9 billion humans. I read that an estimate of the total weight of humans, their livestock and pets now equals close to 97% of the total weight of all land and air animals (excluding insects). If this is even close to true, then we have alot more to worry about than wind turbine effects on the climate.
    Reply
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