US Hydropower Market | Norton Rose Fulbright
The following is an edited transcript from a webinar in mid-March hosted by Infocast about the US hydroelectric market. The panelists are Robert Larson, manager of Nelson Energy, Toni Volpe, CEO of Enel Green Power North America, Bernard (Bud) Cherry, CEO of Eagle Creek Renewable Energy, and Daniel Irvin, CEO of Free Flow Power Corporation. The moderator is Todd Alexander with Chadbourne in New York.
MR. ALEXANDER: Bob Larson, most new hydroelectric projects today seem to be 40 megawatts or smaller in size. Is the day of the large greenfield hydropower project over in the US?
MR. LARSON: Yes, for traditional large-scale hydroelectric projects at dams. We have no working knowledge of the construction of dams. There are not enough years left in my life to take on that portion of development. On top of that, building a new dam involves a number of risks. You hardly ever know what is underneath the river bed. Instead, we focus on adding incremental generation at existing dams, many of which do not yet have turbines. Most of those dams are owned by the US Army Corps of Engineers.
The number of existing dams that work with existing technology and the existing regulatory structure is very limited. Unfortunately, the cost of regulatory compliance does not scale to the size of the project. It is one size fits all. The National Hydropower Association is trying to persuade the federal government to develop regulations geared to small hydropower. It is too early to say whether the effort will succeed.
MR. ALEXANDER: How long is the development cycle?
MR. LARSON: It is a 10-year cycle. Our coffer dams on our first project that we started in 2001 will be watered this week.
MR. ALEXANDER: Daniel Irvin, where do you see the potential for growth?
MR. IRVIN: Two challenges are how to scale an opportunity and make it cost effective and how to control risk over a development cycle. New hydro projects on existing dams are going to be less than 40 megawatts in size. The regulatory cost is not much less than it is for a project that is 1,000 megawatts. Our approach is to try to do projects in groups.
MR. ALEXANDER: When you do projects in groups, are they on the same river, and do they have the same owner?
MR. IRVIN: Same river. It helps also for projects with the US Army Corps to have the same owner. We have gotten states to cooperate. We have gotten US Army Corps districts to cooperate. When we started doing this, I think we had a lot of conventional wisdom thrown at us that we would not get more than one US Army Corps or US Fish & Wildlife Service district to cooperate at a time. If the cluster is big enough, it is worth the investment in time and money.
You asked about large projects. I agree with Bob Larson, with one exception. Large pumped storage projects are still possible. Many people have a sense that there are no longer any very meaningful opportunities left in the United States. I do not think that is true at all. There are opportunities, but it will take real effort to reform the regulatory process.
MR. ALEXANDER: Do you see any opportunity for industry consolidation?
MR. VOLPE: There is opportunity to consolidate small projects and dated projects that need to be re-engineered or partially rebuilt. That is a trend that will continue, certainly more frequently than pure greenfield development, which has a very low chance of happening in the future. It makes sense to look at greenfield development only where there is an existing dam.
MR. ALEXANDER: Is the M&A market more attractive for Enel than building new projects?
MR. VOLPE: We have an existing asset base that we can leverage and a set of competencies already, so a marginal asset sometimes can make a lot of sense. If it is already in a region where we are present, then we can leverage the people that we already have in that area.
MR. ALEXANDER: Bud Cherry, is your focus also buying existing projects?
MR. CHERRY: I agree that M&A is an easier road to growth than developing projects, but it is far from easy. Doing large greenfield projects in the US is very difficult, very time consuming and probably unlikely except in some isolated situations. In the aftermath of the nuclear catastrophe in Japan, the US may — and I stress may — look at the licensing, siting and other rules that are impeding development of new clean energy projects. No one wants to benefit from the kind of tragedy that hit Japan, but it could change the playing field in the US for clean energy.
In M&A, our focus has been on acquiring operating assets of reasonable scale. We have taken a look at advanced development projects and projects that are troubled. The troubled projects either have been mismanaged technically or have compliance issues.
MR. ALEXANDER: Toni Volpe, what is most challenging about trying to acquire hydro projects, and what is most challenging about managing your hydro portfolio as opposed to other types of renewable energy projects?
MR. VOLPE: There are not a lot of assets that end up on the market. Then there are a lot of interested buyers, so it is a fairly competitive sector. What separates bidders is the view each has of the capital costs to maintain the assets for 30 to 40 years. You are usually talking about assets that are already fairly old. Another area that can differentiate buyers is whether an asset falls within an area where there are existing locations that we can leverage and the options that you have to develop further the assets. In most cases, a license is about to expire and you can add additional minimum floater units or even put in a larger refurbishment for a more efficient power plant.
MR. ALEXANDER: How do you view the posture of the federal and state regulators toward hydro and the difficulties of getting hydro projects permitted or obtaining approval for a change in control?
MR. IRVIN: There has been a strange hiatus for last 20 years in the United States during which there has been no new development. The focus has been on relicensing existing projects. The sector is waiting for legislative changes. The regulators are sympathetic to the need to make the regulatory process easier, but there is only so much they can do under the existing statutes.
MR. CHERRY: I think it is fair to say that next to nuclear power, hydroelectric generation is the most heavily regulated form of generating technology. There is little federal oversight in the solar business or wind business unless you happen to be working on federal land. There is a very modest degree of federal oversight in the geothermal business, but again mainly because many such projects are on federal land. The development cycle in the hydro space is the longest of any of the technologies, except perhaps if you are starting with a large greenfield coal project and you have to go through the whole environmental review.
MR. IRVIN: The hydro industry got a level playing field two and a half years ago when Congress authorized developers of incremental hydro projects to qualify for the same 30% Treasury cash grants as other renewable energy projects. Relicensing existing facilities requires a different kind of approach to the regulatory process. It is more risky and time consuming than one normally would tolerate for new development.
MR. ALEXANDER: How do you make decisions about projects not knowing what the tax climate will be, what the regulatory climate will be or even how favorably utilities will look toward signing a power contract by the time your project is ready?
MR. IRVIN: It is different than for a wind or solar project. A great deal is known about hydro. What you install can be there for 100 years. You do not know about the ultimate life of a new wind turbine. Everything that a hydro project can do to the environment is well known. That is not the case with many other types of renewable energy, and I think this will start to level the playing field a little more over time.
MR. VOLPE: When you talk about hydro, you talk fundamentally about a natural resource that is shared. There is only one use for wind or solar irradiation. So it makes sense that there is a more regulated process for hydro. The question is whether it is possible to have a simplified processes to make it last three years as opposed to 10 years. It would help with many of the issues that we have been talking about. Hydro can be in some circumstances extremely cost effective. That’s why we are fairly optimistic that the regulators will adapt to the idea that a streamlined process might help development.
MR. ALEXANDER: What types of returns does one earn on the development capital?
MR. IRVIN: For pure development at a very early stage, 20% or more, but for a project that is already completely licensed with debt and a power contract in place, potentially low teens. The debt is typically in the 7% to 8% range. So, trying to finance the project from beginning to end is extremely expensive. If you try to develop a hydro project the way you would a wind project, you would look at market conditions and say, “power prices are high, let’s do a wind project,” and try to get it done before prices start to enter the down cycle. In hydro, you almost have to start a project when electricity prices are low because of the cycle.
MR. ALEXANDER: How do you analyze a developer’s proposal to add generating capacity at an existing dam?
MR. CHERRY: We would look at where in the FERC process and what issues surround issuance of a license if the license has not already been issued. Beyond that, you would look at head flow and any other issues that might affect output. Do you control the flow? What is the typical annual variation in the flow due to rainfall or other factors?
MR. ALEXANDER: Bob Larson, how do you determine which projects are worth your time and money?
MR. LARSON: We put together an economic model that does not assume any tax benefits. We are not very good at predicting what the government will do. We try to be conservative about the cost of money. We try to be conservative about electricity prices. We put in huge contingency numbers. You do not know what a project will cost until you see the license, and even then you don’t know.
MR. ALEXANDER: How do you see the current low natural gas prices affecting development of new hydro capacity?
MR. VOLPE: This is probably a good moment in the cycle to start developing projects. Hydro can be extremely cost competitive with other technologies. If you imagine a scenario in the long term where natural gas prices stay low and where renewables are going to have to compete with each other just on the basis of their costs, then hydro makes sense.
MR. ALEXANDER: Are projects under 40 megawatts too small to be done on a project finance basis?
MR. IRVIN: Lenders are attracted to a project finance model where they have a pool of projects. It is very, very difficult to finance a $5, $10 even a $20 million project. I think you start to get project lenders interested somewhere between $25 to $50 million and some of the major, most sophisticated lenders will not look at a project that costs less than $100 million. You can get to those levels with a pool of projects, but not a single project.
MR. ALEXANDER: Daniel Irvin, given that a lot of existing dams are small, what kind of strategies are you seeing people use to get a high quality team for operations?
MR. IRVIN: Again, I think you have to aggregate a team around a group of projects. If you look at the bigger owners of clusters or groups of hydro projects, you will see their projects are concentrated in a particular region.
MR. ALEXANDER: Can we provide a general rule of thumb about the minimum electricity price required to support a hydro project?MR. VOLPE: In the past, we have owned or developed projects where the range went from $50 to $60 per megawatt hour to more than $100. It is a very broad range. Most hydro projects sell into the wholesale market at between $60 and $90 per megawatt hour. To provide perspective, wind farms probably sell on average at prices between $60 and $100.