THERE S SOMETHING IN THE AIR: A PRIMER ON WIND LEASES. by Robert P. Wright

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1 THERE S SOMETHING IN THE AIR: A PRIMER ON WIND LEASES by Robert P. Wright In order to understand the dynamics of a wind lease, it is useful to have some appreciation of the current state of the U.S. windpower industry, the elements of a windpower project, and how a windfarm works. This paper will provide a brief background in these areas and then describe the key issues typically addressed in wind leases that are unique to wind development. 1. Introductory Terminology and Concepts. a. Production capacity ( nameplate capacity ) is measured in kw (kilowatts) or MW (megawatts); one MW of electricity will power homes. b. Production is measured in kw-hours (kwh) or MW-hours (MWh). One kwh = 1,000 watts of electricity produced for one hour. So a 50 W bulb running for 20 hours consumes 1 kwh of electricity (50 watts x 20 hours = 1,000 watt-hours = 1 kwh). c. Capacity factor is a measure of energy production of a power plant or wind turbine. It is expressed as a percentage and compares actual power produced over time with the amount of power that would be produced in the same time operating at full nameplate capacity. d. Availability factor gauges reliability of the equipment. It is expressed as a percentage of a year during which the production facility is actually available to produce electricity. 2. Wind Has Become Big Business in the U.S. a. From its modest beginnings in California in the early 1980 s, the industry has taken off at exponential rates in the last several years. 8,358 MW of capacity was installed in 2008 alone, increasing total U.S. installed capacity by 50% in one year. The capacity installed in the last two years constitutes almost twice the total capacity installed in the U.S. previously since the inception of the industry here more than 25 years ago. b. At the end of 2008, total U.S. installed capacity was 25,170 MW, making this country for the first time the world leader in windpower capacity (Germany, previously the world leader, has about 23,000 MW of installed capacity). c. In 2007, new windpower capacity represented 35% of the total new capacity in power generation of all kinds installed in the U.S. during that year, and in 2008 that share increased to 42% according to initial estimates from the American Wind Energy Association (AWEA), the industry s trade organization. -1-

2 3. Industry Challenges. a. There is no question that 2009 will be difficult for the windpower industry, just as it is for others. Two shorter term problems present challenges. i. First, the low prices of oil and gas as competing sources of power production will make some existing projects less profitable and lessen the attractiveness of new projects. As recently as this summer, according to Emerging Energy Research, a Cambridge, Massachusetts-based market research firm, the cost of power from a new windfarm (before tax credits) was 8.4 cents per kilowatt hour, cheaper than power from a new gas-fired power plant (9 cents) or a new nuclear plant (9.8 cents). Only coal, at about 6 cents for kilowatt hour, was cheaper. ii. Second, the industry suffers from lack of available financing. Lehman Brothers, Wachovia and AIG were principal lenders in the industry, and are now gone, sidelined or sold. Credit Suisse, a very large player in the industry, has indicated it is out of the market entirely for this year. And the ability to finance projects through tax equity partnerships (channeling the production tax credits enjoyed by the industry to investors with an appetite for those credits) has shriveled since there are fewer investors now looking to shield profits through application of the tax credits. b. Longer term, there are two significant challenges creating constraints that will need to be addressed. i. Transmission capacity is the most limiting factor. Generally (and not surprisingly), high-voltage transmission lines do NOT run to the areas where the wind is in this country. But a transmission line is essential to transport the electricity to market, since there is no way to store or transport it otherwise. So windfarm development in some states such as North Dakota (which has the most potential for windpower of any state, according to a 1991 study by the Pacific Northwest Laboratory) has been severely hampered as a result. Typically the construction of transmission infrastructure is very costly and time-consuming; a typical project can take 10 years to site and build, and will cost two to three million dollars per mile. Some states, such as Texas, New York and California, have aggressively addressed this issue and have new, accelerated transmission projects planned. But there is a strong move afoot to develop a program of this kind of transmission expansion on a national basis and this is likely to be an area addressed early on by the new administration. ii. Another challenge is the ability to produce turbines fast enough. Growth in the manufacturing sector in the US is behind that of Europe, partly because of the onagain, off-again approach to the industry in this country (see PTC discussion below). During the last three years, turbine availability has been a major constraint, with large developers having significant advantage over smaller ones in having the ability to make and pay for large orders in advance so that supply would not be an issue for them. Development of the industry in this country will be -2-

3 4. Industry Advantages. important to our ability to continue to develop wind farms at a pace that might be achievable absent this constraint. a. Notwithstanding these immediate issues, the industry is in a favorable long-term position and is likely to receive a considerable boost from political policy in the near term. Without fuel cost or any significant carbon footprint, it is going to be a clear favorite and part of the solution for reducing dependence on foreign oil and gasproducing countries and reducing the nation s carbon footprint. b. Two politically-created incentives have provided a great boost to the industry in past years and are likely to continue to do so into the future as they are enhanced and expanded. i. The industry currently enjoys a federal production income tax credit (PTC) of 21 cents per kwh for the first ten years of production of electricity from any projects. This credit was originally created in the Energy Policy Act of 1992 (it was originally 15 cents per kwh but has been increased over time to account for inflation). Congress has been inconsistent in extending the credit, and the industry has seen a 73% to 93% drop in wind energy installations in the year following each of the three years in which the PTC was allowed to expire without renewal (see graph). Most recently, the PTC was extended at the end of 2008 for one year. The inconsistent, short-term extensions that keep the industry and its supply chain in on-again, off-again mode represent one of the big issues that the new administration has indicated it intends to address to encourage longer term stability in growth. (In addition to seeking relief in this area, the industry is also seeking refundability of the PTC or other similar measures to mitigate the effects of the current downturn and the consequent lack of appetite for tax credits that are useful only to those with profits to write them off against.) Source: American Wind Energy Association ii. The second major driver for the industry is the implementation of renewable energy portfolio standards (RPS or RES). These standards use market mechanisms to -3-

4 create demand and ensure that a growing portion of electricity is produced from renewable sources. (a) An RPS requires that electric utility providers acquire a certain amount or percentage of their electricity from renewable energy sources. Generally, a market is created in each jurisdiction through the issuance of transferable RPS certificates for the production of renewal energy. Their value is set by the market. (b) There is currently a drive to implement a federal RPS. (A federal standard has been considered and passed by either the Senate or the House, but not both at the same time, three times since 1997.) So far these standards have been created on a state-by-state basis; 28 states have adopted an RPS, and many have increased their requirements since first passage because the rate of renewable energy development is exceeding their expectations. Examples of current requirements are as follows: (1) New York: 25% by 2018 (2) New Jersey: 22.5% by 2021 (3) Texas: 5,580 MW by 2018 (which has already been exceeded). c. Wind resources are abundant in the U.S. The U.S. Department of Energy s 20% Wind Energy by 2030 Technical Report, issued in July 2008, laid out a plan under which, by the year 2030, wind power could supply 20% of U.S. electricity and reduce carbon emissions by 25%. (This 228-page report is a very good resource and springboard to other resources for learning about the windpower industry in the U.S.; it can be downloaded at d. Advances in technology will undoubtedly continue and will improve prospects for the industry by increasing reliability and reducing costs. In 1981, turbines installed had a rotor diameter of 10 or 15 meters, a nameplate capacity of kw and a capacity factor of around 20%. Today rotor diameters are more typically 80 or 90 meters, generate 2 to 3.5 MW, and have a capacity factor of around 35%. 5. Where are the windfarms? a. Windfarms are located in places where the wind speed averages at least 13 mph AND there are nearby transmission lines. Generally this means the northwest and midwest sections of the U.S., as well as along mountain ridges and coastlines. The following map shows the prime wind development areas in the U.S. -4-

5 Source: United States National Renewable Energy Laboratory b. 35 states have installed utility-scale windpower facilities. c. According to AWEA, in order of nameplate capacity installation, the top five states as of the end of 2008 were Texas (7,116 MW); Iowa (2,790 MW); California (2,517 MW); Minnesota (1,752 MW); and Washington (1,375 MW). (North Dakota, the state with the most wind resource, had only 714 MW installed, an indication of the significance of existing transmission constraints.) 6. Critical Elements in the Development of a Windpower Project. a. Understanding and evaluating the wind resource is obviously fundamental. Wind of at least 13 mph, as previously indicated, with an anticipated capacity factor of at least 25% is necessary for the development to be economic, assuming appropriate pricing. The power that can be generated from wind varies as the cube of an increase in wind speed, rendering locations with seemingly only minimally larger wind speed averages considerably more productive. Generally more than one year of wind data is needed to evaluate the wind resource and its characteristics sufficiently to site turbines on the ground. b. Ensuring proximity to transmission lines, and available capacity in those lines, is also critical. Where no lines exist, there must be an accurate assessment of (i) the likelihood that the transmission lines will become available within the period the developer can retain site control and (ii) the cost of accessing such lines. Even if lines exist, a developer must often get in a queue to determine the priority of its project for -5-