Surprise from a Long Lost Uncle
You recently learned that your long lost rich uncle Ned died and named you as his sole beneficiary. There are now $20 million in your bank account. You want to invest the funds wisely. And, because you consider yourself an environmentalist, you want to do something to benefit the environment.
You have started to look into investing in a renewable energy project. A small wind farm of about 20 MW seems like it might work for you. You decide to name your wind farm project “Breezy Acres, Inc.” What are you going to have to do before you can turn Breezy Acres into a profit making entity?
The Electricity Produced by 20 MW
Breezy Acres will produce enough electricity during a year to meet the electrical needs of about 4000 homes. However, because the wind does not blow all the time, the wind turbines will probably only operate at a 25% capacity factor. In other words, the turbines might be operating at rated capacity only 25% of the year. Thus, the generation from your wind farm project will, at times, be less than the requirements of the 4000 homes and will, at times, be more than the requirements of the 4000 homes.
Converting Wind to Electricity
To produce electricity at Breezy Acres you will use 10 two MW wind turbines. Each turbine consists of two or three rotating propeller-like blades and a nacelle. The nacelle contains the components that convert the rotation of the blades into electricity
As wind blows over the turbine’s blades they will drive a low speed shaft at speeds of about 7-12 rotations per minute (rpm). However, electricity cannot be produced at those speeds. Therefore, the low speed shaft is connected to a gearbox that converts the speed of the low speed shaft speed to about 1,000 to 1,800 rpm on a high speed shaft. The high speed shaft drives a generator which converts the mechanical energy of the high speed shaft into electrical energy.
A wind vane and anemometer are mounted on top of the nacelle. The controller will use the wind direction, measured by the wind vane, to turn the turbine in the direction that will result in the highest rpm of the blades. The controller will use the wind speed, measured by the anemometer, to prevent the blades from turning at speeds of lower than about 14 miles per hour (at which electricity cannot be produced) or higher than about 60 miles per hour (at which the blades can be damaged).
Additional information regarding the operation of wind turbines can be found at energy.gov and in the following video:
Your first job will be to determine if Breezy Acres is even feasible. Until you determine that it is feasible you do not want to spend too much of your inheritance. Therefore, the development stage of the process consists of the following:
- Securing a site at which the turbines will be located;
- Obtaining all government permits required for the project;
- Conducting financial analyses to determine financial feasibility;
- Arranging for an interconnection to the transmission grid;
- Arranging for the purchase of the equipment;
- Securing financing; and
- Deciding whether to sell the output to the market or under a purchase power agreement.
All of the above should be arranged on a contingency, or option, basis. If possible, you should not finalize anything until you know that you are going to proceed with the project.
Selecting a Site for the Wind Farm Project
The most important issue in developing a wind farm project is choosing the right location. Choosing the wrong location can result in the following:
- There may be inadequate wind to generate the electricity needed to make the project profitable;
- The project may be located so far from the transmission grid that the cost of the transmission line required for interconnection will make the project uneconomic; or
- The local market prices for capacity, energy and renewable energy credits may be inadequate to turn a profit.
The Site Must Have Adequate Wind Speed
Wind speeds vary greatly throughout the United States. The following is a map of wind speeds at 50 meters height:
Wind turbines will not generate electricity unless the wind is blowing at least 14 miles per hour. And the higher your wind speed is above 14 miles per hour the more electricity you will be able to produce at your wind farm. So finding the right location is critical to your project’s profitability. As can be seen from the above maximum wind speeds are available along the coasts or in the Midwest.
You will have to hire experts to test the wind speeds at any location that you are considering. Wind blows faster at higher speeds. Therefore, wind speed tests must be conducted at the height at which the windmill will be located. Some of today’s windmills are higher than 400 feet.
The Cost of Interconnection to the Transmission Grid
Your wind farm project will not have any value unless you can deliver your electricity to the grid. Each Independent System Operator (ISO) has a set of rules that govern interconnections of new generating facilities to the grid. All of these rules require that you, as the owner of the new generator, pay all costs incurred by the ISO and the transmission owning utilities to accommodate your facility. Those costs include the following:
- Any engineering costs incurred to design facilities required for the interconnection;
- The costs of the transmission line that runs from Breezy Acres to the closest utility owned transmission line;
- The cost of interconnecting the new transmission line to the existing grid; and
- The cost of any impact the operation of Breezy Acres may have on other remote locations of the grid.
It may take the ISO several years to determine the costs of interconnection. And those costs, which could be several million dollars, could be the difference between profitability and failure of the project. Therefore, you cannot make final plans for the project until you get that interconnection cost number from the ISO.
Revenues From the Sale of Capacity, Energy and Renewable Energy Credits
Breezy Acres will produce three products available for sale to the market – energy, capacity and renewable energy credits (RECs). The quantity produced and the price for each will make or break the profitability of the project. For more discussion on sales to the competitive power market see the Post entitled Electricity Sales in a Power Market. You can hire an expert that can project the revenue that your wind farm project is likely to recover once it is in operation.
Revenues from Sales of Capacity
Capacity is the power, in MW, that Breezy Acres will be able to deliver to the system at any time. Your turbines will be rated at 20 MW. So 20 MW could be the capacity that Breezy Acres has available for sale. But the ISO depends upon capacity to make sure that the lights stay on. And since the wind does not blow all the time no one can be assured that 20 MW from Breezy Acres will always be available to power the lights.
You will have to run tests to determine exactly how often the 20 MW at Breezy Acres can be relied upon. These types of projects typically have a capacity factor of about 25%. Therefore, Breezy Acres may only be able to sell 25% of the 20 MW of rated capacity – or 4 MW.
Your expert can project the price for capacity, in $/MW/month. But you will not know the exact price until the ISO conducts its capacity auction for a forward period. It is not unusual for developers, like yourself, to delay construction of your project until you are assured that the capacity prices arising out of the capacity auction will be adequate to generate a necessary profit.
Revenues from the Sale of Energy
Energy is the electricity that Breezy Acres produces while it is in operation. Your expert can project the quantity of electricity, in MWh, that Breezy Acres is likely to produce in any year.
If you are selling into the ISO market the price for each MWh of energy will change by the hour depending upon the demand for electricity on the ISO system in that hour. The price that the ISO pays for energy in any hour is based upon the running costs of the most expensive generating unit that is generating electricity. Your expert should be able to project the energy prices, in $/MWh, for a typical year of operation.
During many hours of the year, when demand is low, the price of energy is based upon the very low running costs of a renewable plant or a nuclear plant. However, during those very hot spells of the summer, when everyone is running their air conditioning night and day, all generating plants, even the most expensive oil burning plants, are called into action. And the running costs of those expensive plants set the energy price for all plants that are producing electricity during the hour.
You may commiserate with your friends and neighbors who are complaining bitterly about the heat and their electric bills during those hot spells. But you will also know that the revenue that you receive for sales during those hot spells are what will make Breezy Acres profitable.
Revenues from the Sale of Renewable energy credits
Electricity produced by wind turbines is a premium product. Many states require their electric providers to include a certain amount of renewable energy in their energy portfolio. And many competitive retail electric suppliers offer their customers electricity that is primarily produced from renewables. This creates market demand and makes energy produced by renewables a little more expensive than other forms of electric energy.
Electricity produced by renewable plants is intermingled with other electricity on the grid. So it is impossible to prove that electricity produced at a renewable plant is being delivered to a particular customer. However, each kWh produced by a renewable plant is accompanied by a Renewable Energy Credit, or REC, which can be sold independently from the kWh. Purchase of an REC is proof that the purchaser has bought renewable energy for resale.
Breezy Acres will be producing an REC for each kWh that it generates. You will be able to sell these RECs on the open market. Your expert can project the revenues that you are likely to recover from the sale of RECs.
Securing the Site
Because each wind turbine can interrupt the flow of air to the other turbines you need plenty of space for your wind farm project. You might need as much as 500 acres. You do not need to own 500 acres of land. More likely you will want to lease 500 acres from one or more farms. The farmers will be able to use the land around your turbines as long as they do not interfere with your operation.
The cost of these leases could be between $60,000 and $80,000 each year. However, you do not want to start paying for these leases until you are sure that you are going to proceed with the project. You should be able to secure the site by entering into an “option to lease” for a small amount of money. You will convert the option to a lease when you are sure that the project is going to proceed.
Financing the Wind Farm Project
You will have to go out and obtain bids for the cost of installation of your 10 two MW wind turbines. However, typical total costs are around $40 million for this type of project. Your expert projects that net annual profits from the operation of Breezy Acres should be around $6 million. His projection is just an educated guess. But if he is right you will be making a 15% annual return on a $40 million investment. And even if he is off by a little it still looks like a great investment opportunity!
But Uncle Ned did not leave you $40 million. He left you only $20 million. You are going to have to borrow the remaining $20 million from a bank. Interest rates for a company like Breezy Acres might be around 10%. So annual interest payments for a $20 million loan will be $2 million.
You expect that it will be easy to get a loan. After all, the project is going to throw off $6 million each year, well more than the $2 million interest payment owed to the bank.
But banks do not have the same appetite for risk that you do. Your anticipated annual earnings are based upon your expert’s estimate of the market prices for capacity, energy and RECs. The bank does not want its loan repayment to be dependent upon the volatility of market prices. They tell you they will not approve a loan for your wind farm project unless you can assure them of fixed capacity, energy and REC prices.
The Purchase Power Agreement
The only way to fix the capacity, energy and REC prices is to enter into a fixed priced purchase power agreement under which you sell all of the Breezy Acres output to a purchaser at a fixed price. There are plenty of participants in the energy markets that will be happy to enter into such a purchase power agreement. They will purchase your output and sell it into the market at market prices. However, that means that they are taking on the risk of the volatility of market prices. In order to take on that risk they will want the fixed price that they pay to leave them plenty of opportunity for profit. In other words, they are going to want some portion of that anticipated $6 million in annual profit.
Figure that the purchaser under the purchase power agreement will want to keep one third of the anticipated profit. This leaves Breezy Acres with only $4 million of profit under the fixed price purchase power agreement. Of that $4 million you will have to pay $2 million to the bank in interest payments for the $20 million loan.
That leaves you with $2 million of the total $6 million in potential profits from operations of Breezy Acres. But $2 million is still a 10% return on your $20 million investment. And, with the purchase power agreement, you no longer have to contend with the uncertainty regarding the price for sales. Therefore, it still seems like a pretty good investment of your inheritance.
I. David Rosenstein worked as a consulting engineer and attorney in the electric industry for 40 years. At various times during his career he worked for utility customers, Rural Electric Cooperatives, traditional investor owned regulated utilities and deregulated power generation companies. Each of his posts in this blog describes a different aspect of the past, present or future of the electric industry.