Report: Wind farm project returns dropping 

The wind power market in the United States remains “white hot,” yet returns associated with such projects have eroded.

“Profit expectations, once generally above 20% on an after-tax basis, are now often at or below 10% due in large part to well-capitalized European players that currently dominate the transaction market,” states R. John Dingle, a partner with consulting firm Thorndike Landing, in a September 2007 research report.

Rising development costs has been a challenge for many project developers, owners and operators, along with the increased competition for wind development projects and operational wind farms has driven down returns for investors in assets and the businesses that develop them, according to Dingle’s report, “Wind Sector Margins: Catch the Tail Wind.”

European players in the U.S. wind market have made their presence felt. Dingle notes, for example, that of the 12 largest deals done in this space in the last year, nine involved European entities, including Energias de Portugal, Iberdrola SA and BP plc, and that “combined, these deals involved more than 75% of the capacity transacted during this period.”

The current credit crunch will also provide “significant opportunities” for foreign entities and U.S. utilities with strong balance sheets, whereas thinly capitalized players in the space will suffer, Dingle said. Even financial players that require financing for wind transactions will be hindered by the current credit situation.

Dingle also notes that while wind turbine manufacturer General Electric Co. has nearly 50% of the U.S. market share, foreign companies such as Vestas and Gamesa SA, which have dominated the global markets, are making inroads into North America.

“Our view is that, on a global basis, other turbine suppliers (e.g., GE, Siemens Corp., etc.) will continue to take market share away from the current incumbents (e.g., Vestas, Gamesa, etc.). We’re not suggesting they will conquer this market overnight nor will it drive turbine costs downward, but we do see a hard push for market share by these suppliers which may temper the rise in overall installed cost,” Dingle states.

The outlook on the U.S. wind sector remains strong due to state and federal mandates and incentives for renewable energy resources.

Indeed, as a result of these policies, the market is “in the midst of a significant supply/demand imbalance,” according to Dingle. High demand for wind turbines has enabled manufacturers to boost prices well above production costs.

The pace of project deals shows no signs of slowing down, according to Dingle. “Buoyed by several large deals in the past year, the churn in transaction volume continues to increase as more than 42 GW of capacity traded hands – that’s more than several times the current operating wind capacity in the U.S.” Dingle notes. “Additionally, the capacity transacted in the first half of 2007 represents more capacity than those interests transacted in all of 2006 – a clear up-tick in transaction volume.”

Installation costs are expected to climb over the long term for several reasons. As the worldwide shortage of wind turbines continues, orders are being placed years in advance; currently, orders have been made through 2010 and into 2011, according to Dingle. “This frothy demand for turbines, tight production capacity, impending extension of the PTC, and the current high level of commodity costs setting power prices will cause turbine manufacturers to continue to enjoy the current sellers market through this period.”

Natural gas prices shall continue to boost the wind market, according to Dingle. The current plateau of natural gas prices will remain in place for the next several years, according to Dingle, thus firming up the demand for renewable resources, namely wind generation.

The high returns associated with these facilities for the past few years will likely be obtained going forward through high-risk projects.

“Going forward the higher margins in this sector will be increasingly found in the earlier-staged developments and/or entities with those portfolios, wherein the acquirer will be putting less of its capital at play in the acquisition and more of it at work throughout the development process,” Dingle states. “The entities that will prosper in this sector during the short- and mid-term will be those with stable balance sheets and the financial wherewithal to fund these acquisitions largely out of operating cash flows vs. tapping the already-strained debt markets.”

By Jennifer Zajac

www2.snl.com

3 October 2007