Host Daniel Raimi talks with Jay Bartlett—a research associate at RFF—about his recent work on wind energy development. Jay explains how wind projects actually get built, i.e., how developers raise money for their projects and who they sell their electricity to. Daniel and Jay also discuss how state and federal policies shape these markets, and how the coming changes in the policy landscape are likely to affect future wind development.
Listen to the Podcast
Top of the Stack
References and recommendations made during the podcast:
- "Reducing Risk in Merchant Wind and Solar Projects through Financial Hedges" by Jay Bartlett
- News of the World by Paulette Jiles
- The Son by Philipp Meyer
- Our Planet
The Full Transcript
Daniel Raimi: Hello and welcome to Resources Radio, a weekly podcast from Resources for the Future. I'm your host, Daniel Raimi. This week we talk with Jay Bartlett, a research associate here at RFF, about his recent work on developing wind energy. Jay will tell us about how wind projects actually get built. That is how developers raise money for their projects and who they sell their electricity to. We'll also talk about how state and federal policies shape these markets and how the coming changes in the policy landscape are likely to affect future wind development. Stay with us.
Daniel Raimi: Okay. Jay Bartlett, my colleague at Resources for the Future. Thank you so much for joining us today on Resources Radio.
Jay Bartlett: Thank you for having me.
Daniel Raimi: So Jay, we're going to talk about a recent working paper that you wrote about wind energy in the United States, and some of the financing structures around developing wind energy. But can you first tell us a little bit about how you got interested in energy and environmental issues in the first place?
Jay Bartlett: Yeah, it was interesting because my first few jobs had very little to do with energy policy, sort of on the face of it. My first job was as a biophysics researcher and my second job was as an investment banking analyst. But the interesting thing with finances, I've found it to be particularly useful in energy policy. Finance really sort of asks the question, is an incentive valuable enough and how risky is it? And I think those two parts end up being very important when you're looking at energy policy.
Daniel Raimi: Yeah, that makes sense. And I'm really glad that you have a finance background because I'm going to need your help understanding some of the finance issues that you talked through in your paper that we're going to talk about. So I'm looking forward to learning from you about that. The name of the working paper so our audience can look it up, we'll also have a link to it on the show page, but the name of the paper is “Reducing Risk in Merchant Wind and Solar Projects through Financial Hedges.” And so, we'll kind of unpack that over the next 20, 25 minutes.
But just a little bit of background first, which is about the growth of wind energy in the United States. And we're really going to focus on wind today. So, in 2005, wind accounted for less than 1 percent of total net electricity generation in the United States. In 2018, it was more than 7 percent. So, really amazing, rapid growth in wind energy in the US. Development is taking place in 40 states of the United States. There are at least some wind turbines in 40 of the US states, with the largest producers being Texas, Oklahoma, Iowa, and Kansas. So, with that little bit of background in place, Jay, can you tell us the two main ways in which wind energy developers actually sell the electricity that they generate? And also explain why a developer might prefer one option over another.
Jay Bartlett: Of course. Yes, I think the first thing I should mention is the vast majority of wind projects are not owned by a utility. That's less than 10 percent the market. So, for the vast majority of wind projects, as you said, they're owned by a project developer, and they have these, sort of these two choices on how they're going to sell. Either they can sell under a long-term contract, known as a power purchase agreement, or a PPA, or they can sell into the wholesale markets. So we call wind generators selling into the wholesale markets, merchant generators. And really, the choice between a PPA and a merchant arrangement for a wind project developer is really sort of a classic trade off of risk and return. A PPA has the advantages of being low risk, but it also is rather low return. A merchant structure is quite the opposite.
Daniel Raimi: Right. And so, when operators make each of those two choices, who is on the other end of the transaction? So, if it's a PPA who is entering into that long term relationship with a wind developer, and if it's a merchant, a merchant generator, then what is the pool that is bidding into, and who's on the other side of it?
Jay Bartlett: Yeah. So the vast majority of PPA's for wind in the US are with utilities. So, in that case you really have quite a limited pool of potential customers. You're talking about utilities, utility co-ops, and that's really the reason why PPA prices get pretty low. Because you have all these wind projects that are competing for them and it's a low risk structure. So, that's driving PPA prices down.
If you're a merchant generator, you're selling into the wholesale market, the buyers of that electricity could be any participant in that market. And then, as we'll sort of discuss a little later, what you'll have is a counterparty with your hedge. Maybe that's sort of jumping a bit ahead. So, you'll have another sort of party involved, but it won't be an actual contract with an electricity offtaker.
Daniel Raimi: Well, yeah. So let's get into that, that issue of hedging. So, as you mentioned, when developers choose to operate as merchant generators, your paper talks about how they typically use these financial hedges. So again, for ignorants like me, can you get us up to speed on what financial hedges are? And second, why is it useful for a developer to dive into one?
Jay Bartlett: Yeah, so the hedges that we're looking at, you could really refer to them as swap contracts. What the developer's doing is they're swapping the actual electricity prices that they will receive for a predetermined fixed price. So, you have one party which is the developer offering up actual electricity prices. The counterparty in that hedge is offering up a fixed price, and they're swapping the two of them. So, the developer is giving up some revenue. Generally, the actual electricity prices are going to be greater than the fixed price they're getting in return. So the reason why they're doing that is, basically they're getting more revenue certainty. They're almost guaranteeing themselves a certain amount of revenue. And that ends up being critically important because of the financing of these projects.
I think one of the things that's important to know about wind projects, and this is true of solar as well, is that the project developer generally puts up a very small portion of the capital required to install these projects. So, the other financiers are usually debt providers. A lender, a bank, and what's known as a tax equity investor, that's necessary for these tax credits that we'll talk about in a bit.
So you have these two other parties to the transaction that are pretty risk averse, particularly a lender. They want to see that constant stream of interest payments. Any risk that puts that in jeopardy is something that they're going to strongly avoid. So, a merchant project, which has these fluctuating energy prices is a pretty unattractive proposition for a lender. So, that's really kind of what is driving hedges for merchant wind projects.
Daniel Raimi: And sort of similar question to the followup I had with the last question, which is; who's on the other side? So, for a wind developer that's entering into a hedge situation, they are going to have a more stable price that they receive, but someone else is going to be subject to the volatility in prices that the wind developer is trying to avoid. So, who's on the other side of that transaction? Who's taking on that volatility or that risk?
Jay Bartlett: Exactly. Yeah. And that's a good question. So in the paper, we look at five different possible hedging structures, and so that counterparty is going to differ depending on which hedging structure we're talking about. But, in the most popular ones, the two most popular hedging structures right now, one is called a bank hedge. And so, in that case, as sort of the name would imply via the counterparty is a financial institution, and often it's the same financial institution that's helping with financing the project. So often the same as is the tax equity investor. So, usually, a sophisticated investment bank that has a lot of business. They're going to be the ones that are providing that hedge product. So that's sort of for bank hedges.
For the other structure that we see most common in the marketplace now is something called a synthetic PPA. And I won't sort of go into the weeds on it, but what's important with that is instead of a bank that's providing the hedge, it is a large corporation, a non-financial corporation. So all the deals that we've heard about recently, whether it's Facebook or Amazon or Google, making wind deals or solar deals, those are generally synthetic PPA’s. So they're basically taking on that risk of price volatility in return for renewable energy, over a 10 to 15 year period.
Daniel Raimi: Right. Interesting. Yeah, those deals have been in the news a lot, and it would actually be great maybe to come back some other time and talk about them in particular, and what they mean, and sort of how they're structured and all that. But, let me take a step back and go back to these sort of two general approaches that you mentioned earlier. So, one is the PPA and the other is going to the merchant market with a hedge. So, do we have the data to know whether one approach tends to be more profitable than another, or in what situations one approach might be preferable?
Jay Bartlett: Yeah. So, our best data is from Texas, and not surprising given the amount of wind that's been installed there over the last 10, 15 years. The most profitable of those structures tends to be the riskiest, which is a pure merchant unhedged agreement. However, that's very difficult to finance for,sort of the reasons we just talked about. And so, it's something you rarely see. I came across one in 2017. There might be a couple others in 2018, but the problem is it's very difficult to get a lender or a tax equity investor to commit to financing something that is totally unhedged in the future. But if you were able to get it financed, and a couple deals have been able to do that, it would be the most profitable possible venture. And so, it's really sort of that classic trade-off of risk and reward. And so, what I'd say sort of, the deals that are kind of in the middle of hedged structures are higher profit than a PPA, but lower profit than a pure unhedged agreement.
Daniel Raimi: Right. And so if you're totally unhedged you have the potential for a big upside, but you also have potential for a big downside, right?
Jay Bartlett: Exactly. And I think one of the things that's sort of important with this is that you have differing incentives of the parties involved. So, in the classic wind deal where you have a bank providing the debt, a tax equity investor, and the project developer, you have varying incentives. The project developer sort of gets all the upside, the bank gets none of the upside. So, you’re really sort of looking at, okay, given the people involved, or the institutions involved, what is going to be sufficient to make everybody agree to this? So that, I think, is sort of how to kind of look at a wind deal, and the type of structures in terms of hedging that they ended up choosing.
Daniel Raimi: Right. Interesting. So, one other question that comes to mind is the role that state government policies might play in this discussion and how it might affect incentives. So, renewable portfolio standards, these are fairly common policies in a variety of states where states require that a certain amount or a certain percentage of energy comes from a source like wind energy or solar energy.
But if, let's say for example, a state requires a certain amount of energy to come from wind, but project developers in that state are having a hard time finding a profitable way to develop all that energy. So, in this case, an economist might say the RPS is binding. What types of incentives exist that allow financiers to get involved and actually develop that project when it might not be profitable absent the policy, the RPS?
Jay Bartlett: Absolutely. Yeah. In that case, because as you said, it's a binding mandate, you'd see a really high REC price, really high renewable energy certificate price that would overcome that shortage, that would provide the necessary incentive for, say a wind project, to be financed and installed. So yeah. It's state policies. State RPS policies are, and historically have been, an important driver of wind projects.
But interestingly, what we've seen in the last five years is the opposite. In the last five years we've seen REC prices in most of the markets drop by about a third, or actually two thirds, in fact. And we're also seeing more and more wind and solar projects that aren't being used to meet a state RPS. So in the beginning you mentioned Texas and Oklahoma and Kansas and Iowa. All those states, either don't have RPS's, or they've already exceeded them. So you're seeing wind go into these states on a purely, or I should say sort of without the need of an RPS to drive it. Wind has become sufficiently profitable, sufficiently competitive, that it often does not necessarily need those RPS policies to make the deal financeable.
Daniel Raimi: Right. And around what time, I guess you said about five years ago, but do you have a sense of, broadly speaking, what parts of the country are sort of exceeding the RPS's that are in place, versus where in the country RPS's are still binding for wind energy development?
Jay Bartlett: Yeah. So really, sort of the center of the country, where the greatest wind resource is. That path from Texas sort of up through Iowa and Minnesota, that's where you're seeing the most wind development. And most of those states didn't have particularly stringent RPS requirements, but because they had such a good wind resource, that's where you're seeing sort of the majority of this wind go in. And that's particularly true on the merchant side. I mean, it's true for wind in general, but it's particularly true for merchant winds.
Daniel Raimi: Yeah. We had Sarah Mills, who's a researcher from the University of Michigan, on the show a number of weeks ago, and she referred to that middle part of the country as the wind belt.
Jay Bartlett: Yeah.
Daniel Raimi: Do people call it that, or is that something she made up? Is that a common term?
Jay Bartlett: No, I think I've heard that. I've heard that. I've heard, the Saudi Arabia of wind. I've heard various sort of phrases to describe it, and it is, for an onshore wind resource, it is pretty fantastic.
Daniel Raimi: Interesting. So, we were just talking about state policy and RPS policies. Let's shift over and talk about an important federal policy, which is the production tax credit, or the PTC. That's been a tax credit that has sort of gone on and off sporadically over the last several decades. And it's provided a few cents for every kilowatt hour of wind energy that's been generated in the US since the 1990's. But the PTC has been steadily declining over the last three years due to an agreement reached, I want to say, in 2015, and the PTC's scheduled to be phased out entirely at the end of this year, 2019, if I'm not mistaken.
So assuming it does sunset into the distance, how is the removal of the PTC likely to affect the outlook for wind development over the next several years? And how might those incentives vary in a place like the wind belt versus a place like New York State, or another place where the wind resource might not be as great?
Jay Bartlett: Yeah. Well, interesting actually, sort of for the next few years, it's going to be very strong wind installations in the US. So the reason behind it, when they came to that agreement that you mentioned, one of the important parts is that those years that the wind PTC is phasing down, the date, or sort of the milestone that's important is that the wind project needs to commence construction before the end of that year, and it's a pretty lenient requirement.
One of the tests for that is just that the project spends, I believe it's 5 percent of the total project cost. So basically, you've had a lot of wind projects over the last several years meet that deadline, and so they will be installed over the next few years. I think I saw at the end of 2018 that the pipeline for wind projects either being constructed, or in advanced development, was 35 gigawatts. Sort of by comparison, last year about seven gigawatts was installed. So, you have a lot of projects that are sort of in the queue right now. So the next few years should be, basically sort of developers rushing to finish these projects, and that will be substantial. So then after that, say, 2022, '23 you're going to have a big dropoff.
Interestingly, I was looking at the annual energy outlook recently, and EIA actually forecasts almost zero wind from 2022 onwards, for the next, about 20 years, because of the lack of PTC. I'm not quite that pessimistic. I think you're still going to get at least a fair amount of wind going in. But it does show how important the PTC has been to wind, and what other policies are going to be necessary to maintain the growth in wind.
So I think, sort of going back to our earlier question about states, a lot of it will kind of kick it back to the states, and that's been an encouraging thing over the past year. Last year, it seemed to be that most RPS policies would sort of level off in the mid 2020's, but in the last... I mean it seems like every week or so I get another announcement of another RPS policy being extended or sort of raised in its requirements. This includes California, so some big states with some big markets. So I think the importance of state policy will be renewed over the next several years as the PTC goes away and these projects are looking to something else to make sure they're financeable.
Daniel Raimi: Right. And we do see these big commitments to sort of rapid decarbonization of the electricity sector in places like California, even New Mexico, and Washington State. So, those might be sort of key drivers going forward.
Jay Bartlett: Absolutely.
Daniel Raimi: The other thing that came to mind as you were talking was the EIA and its longterm projections for wind energy. There's sort of a long ongoing debate about how bullish or bearish the EIA is about wind energy and solar energy projections. And, I'm not going to sort of go down that rabbit hole, but just want to note that that has been an area of discussion for a lot of energy folks, some who have argued that the EIA has sort of been on the low side for projecting the growth of renewables in particular.
Jay Bartlett: Yeah. I should also mentioned that, I think, the most recent annual energy outlook was factored in RPS policies as of, maybe October of last year. So it doesn't actually sort of include a lot of the recent action. So there's, even sort of on a pure modeling basis, there's room that has not been accounted for over the last several months of development.
Daniel Raimi: Right. So one last topic that I want to touch on with you, is not about policies, but more about markets, which is the issue of low electricity prices. And this is something you talk about in your paper in some detail. So, in the world of oil and gas, which is a world that I'm more familiar with than wind finance, US companies have been producing more and more oil and natural gas. And sometimes, folks in that industry might say that they're kind of eating their own lunch by over producing oil or overproducing natural gas and crashing market prices. Does wind face that same type of risk as it grows so rapidly in some parts of the country and provides a larger share of the power mix?
Jay Bartlett: To some extent. And here I'll sort of a draw a contrast with solar because I think with solar you really see that dynamic. If you've heard of the duck curve in California, if you Google that it's worthwhile, because what we've seen in markets like California for solar is, even with 10 percent of solar on the grid, you see a strong depression in solar midday prices, which obviously solar would benefit from. So I mean those prices are down 50 percent plus in California over the last several years. So, with solar you really see that dynamic.
And the advantage of solar is that relative to wind it's more predictable. But also, it's concentrated in very specific hours of the day, and so you really get that sort of dynamic. Wind is much less so, because it's dispersed throughout the day, you get some price erosion, but not nearly to the same extent. So, that's something that I worry a lot with solar, and I think really argues for the importance of storage and flexible demand. I think that's important with wind, but not as much.
Daniel Raimi: Right. That makes sense. I guess, I mean I have seen the occasional news story about negative electricity prices in the evenings, and my recollection is that those are often associated with wind. Maybe also nuclear a little bit, but can you talk a little bit about those negative prices and how frequent they are, how important they are for wind projects?
Jay Bartlett: Yeah. And for wind that's very much an effect of the policy in question, the production tax credit, because when projects received that, so long as they generate at the production tax credit value of, let's say a little over 2 cents per kilowatt hour, even if the wholesale electricity price is negative, even if it's negative one and a half cents per kilowatt hour, as a wind project, you're still going to want to generate so you make sure that you receive that PTC. So, the negative prices with wind is very much a policy driven effect. I would expect as the PTC is declining that that will be less of an issue.
Daniel Raimi: Yeah. Probably not something the designers of that policy had in mind when they put it together. Something we would maybe refer to as an unintended consequence.
Jay Bartlett: Exactly.
Daniel Raimi: Yeah. Well, Jay Bartlett, thank you so much for telling us about all this stuff related to wind. It's really fascinating, and I learned so much just over the last 20 minutes talking to you.
Jay Bartlett: Thank you for having me.
Daniel Raimi: Yeah, absolutely. So, before we let you go, we want to do our final segment where we ask you what you've been reading or watching or listening to, that you've been enjoying lately related to energy and the environment that you think might be really interesting for our listeners, and something that you'd recommend.
So, I'll get us started with a couple of book recommendations. There are two books, one of which I finished, and one of which I'm in the middle of, about Texas, that are really great. And for anyone interested in energy, I think you have to be interested in Texas, whether it's about wind, as we've been discussing today, or oil and gas, or increasingly solar energy. Texas is a very energy rich place. And the two books I've been reading, neither of them address energy directly, but they're both about Texas history in ways that are really wonderful.
So, the first book is called News Of The World by Paulette Jiles. This was actually recommended to me by friend and colleague, Amy Pickle, at Duke University. And this is a wonderful book about a young girl and an older man sort of traveling across Texas and getting to know each other. The second book has been out for a while, but I'm just starting to read it now. It's called The Son by Philipp Meyer. S-O-N. And, it's also a book about Texas history, about a family in Texas that spans generations. I think there's actually a TV show now based on the book called The Son starring Pierce Brosnan, which I have not watched. But, the book itself is quite wonderful.
So, both of those books I'd really recommend, especially if you want to learn a little bit about Texas. News Of The World and The Son. So, now over to Jay. Jay, what's at the top of your literal or metaphorical reading stack?
Jay Bartlett: Well, I'm sure it's a common one, but I'm such a huge David Attenborough fan. I've seen Blue Planet, and Planet Earth, and Life, and Human Planet, and Frozen Planet. So, of course right now I'm watching Our Planet on Netflix.
One of the things I think is interesting about it is, all of his recent programs have at least sort of touched on climate change, the impacts of people in the environment. But, with this program, it's really sort of the core emphasis of it. And I think having visuals, one, it shows you the magnitude of the change, and I think it also, by showing these fantastic places, it really gives you reason to care. It gives you sort of a sense of their value.
But I think that one of the questions it poses to me that I find really interesting is, to what extent can animals and plants adapt in a pretty short period of time? So, where will we see adaption, where will we just see loss? I think that's a really depressing, but important scientific question with respect to the environment.
Daniel Raimi: Fantastic. Great. Well, Jay Bartlett, thank you again so much for joining us and being with us today on Resources Radio. We really appreciate it.
Jay Bartlett: Thank you.
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