The US put incentives in place in 1978 after the Arab oil embargo to encourage more use of renewable energy. They were allowed to lapse in 1985. The incentives were restored in 1992 and increased in the last decade, but they are now in danger of lapsing or being shed in an effort to reduce corporate tax rates at a time when low natural gas prices and slow load growth are already taking a toll on renewable energy developers. What is a survival strategy during such periods?

Four senior executives of renewable energy companies shared their thoughts at the Chadbourne 23rd annual global energy and finance conference in Stowe, Vermont in late June. The four are Martin Mugica, executive vice president of Iberdrola Renewables, Paul Gaynor, CEO of First Wind, Robert Mancini, CEO of Cogentrix Energy, and Michael Storch, executive vice president and chief commercial officer of Enel North America. The moderator is Keith Martin with Chadbourne in Washington.

MR. MARTIN: Martin Mugica, Iberdrola came to the United States to do wind projects. What is it doing today?

MR. MUGICA: We started diversifying last year into solar. Right now we have
50 megawatts of solar facilities in operation: 30 megawatts in Colorado and
20 megawatts in Arizona. We have been interested from the start in biomass, and of course we have a lot of wind. We are open to other opportunities, but at this point this is what we have in our portfolio.

MR. MARTIN: Paul Gaynor your company is called First Wind. Will we see a name change in the future? (Laughter.)

MR. GAYNOR: Everybody keeps asking that. We have 1,000 megawatts of operating wind farms. We have done 1,200 megawatts of transmission assets, all on the back of our existing portfolio. We have done two large battery projects. We are working on a solar project, but what I call related solar that is adjacent to one of our wind facilities, and we are working on a natural gas play in the Pacific Northwest again on the back of our wind business infrastructure that we already have.

MR. MARTIN: Bob Mancini, Cogentrix was originally a developer of coal-fired power plants and then Goldman Sachs bought it, and the company has changed its focus. What is the focus now?

MR. MANCINI: Cogentrix was a developer of conventional thermal power plants, both coal and natural gas. We started to venture into renewables in 2008, but solely in solar. We do not develop any wind. There was a group within Goldman Sachs at one time, Horizon, that was another team that developed wind, but that was separate from Cogentrix. We made our first play by buying 43 megawatts of the SEGS facilities in California. We sell our power to Southern California Edison under a long-term contract. The next year, in 2009, we started developing a large concentrated photovoltaic power plant. It is 30 megawatts. It went commercial a couple months ago and, I believe, is the largest CPV project in the world at this time. We are working on a 150-megawatt project in the Imperial Valley that uses more conventional photovoltaic technology. I don’t think we will see another CPV project in this country any time soon given how low panel prices are.

MR. MARTIN: Mike Storch, Enel acquired hydro projects and developed wind when it first came to the US. What is it doing today?

MR. STORCH: Enel Green Power is the only Enel company currently active in North America, and it does all renewables. We have solar, hydro, wind, geothermal and biomass projects in operation, and we are also starting to combine technologies. We recently dedicated the first combined geothermal and solar PV facility in the world as far as we know.

MR. MARTIN: Are you shifting developers from wind to the other types of projects you mentioned?

MR. STORCH: There is a shift, mostly toward solar, because of what is happening on the tax side. We have the next three or four years to get some solar done and still benefit from the tax subsidies for solar.

MR. MARTIN: The production tax credit may run out for wind at the end of this year. If it does, will it be a case — if one thinks of the wind industry like a large plant — of the water being cut off before the plant can truly take root?

MR. MUGICA: I think the position of the wind industry in the US is pretty material, so the plant is of some size already. The problem is there is a danger of the plant withering and parts of it dying under current weather conditions: low natural gas prices, transmission constraints, low load growth and inability to get utilities to enter into long-term power contracts. If we were facing healthier market conditions, we could probably live without production tax credits. Wind has a future in a normal market.

Good Time for Acquisitions?

MR. MARTIN: I met with a CEO of a wind company at the Global Windpower 2012 convention in Atlanta last week who has raised a fund to buy operating wind farms. He said he hears so many complicated business plans, but his business plan is simple. The market is depressed. Wind assets are cheap. He thinks the market will recover by 2015. “I buy low and sell high,” he said. Paul Gaynor, do you see a recovery by 2015?

MR. GAYNOR: Yes. It is an opportune time to look at acquisitions. We have three of what I call little acquisitions. Ironically, we are sitting today on a large pile of cash that it makes sense to try to deploy by buying projects. Temporary production tax credits make this a difficult business to manage. This will get me into trouble with my colleagues, many of whom are in the audience, but I think the best thing that could happen to the wind industry, frankly, is if the PTC went away. It is absolutely brutal to manage this business year to year when you don’t know what is going to happen. We are incredibly busy this year and, on January 1, 2013, we will have nothing in the pipeline. That is the challenge.

That is why we are looking at solar. That is why we are keeping busy with transmission lines. Even as a wind company, we have never covered the entire US. We have been focused on a handful of states with strong renewable portfolio standards: the New England states, New York and, to a certain extent, California and Hawaii. Those are some places that we might still be able to transact without a PTC because a higher price for renewable energy credits has the potential to make up some of the lost revenues from the PTC.

MR. MARTIN: I read this morning that Riverstone Holdings, which owns Pattern or a large stake in Pattern, is now putting its stake in that company up for sale. Is this a good time for people to be exiting the business if prices are depressed? It seems to be a good time to be a buyer rather than a seller, no?

MR. STORCH: It depends on what you are selling. Contracted operating assets remain very attractive. People will look at a pipeline of development projects that still needs to be contracted for power sales and built as a liability rather than an asset. There are selected opportunities. We are seeing wind projects today that are economic with production tax credits and power prices in the low $30-per-mWh range on a levelized basis. Losing the PTC increases the amount of revenue needed over a 20-year power contract by more than $20 a mWh. So a project with a power contract that pays $55 mWh in an area with a high capacity factor can be competitive without tax credits. Continuing improvements in technology can only make things better.

MR. MARTIN: So in that sense, the PTC has served its purpose, or at least helped, by helping the industry to reach scale: inducing efficiencies and bringing down cost to the point where you can compete at current market prices.

MR. STORCH: Yes with projects in places like Kansas and Oklahoma with really robust wind resources, but part of the challenge is the load is not there — it is in the big population centers elsewhere — and there are not the transmission lines to move the electricity. A lot of the low-hanging projects that work with power prices in the $30-per-mWh range have already been developed.

MR. MARTIN: Do you share Paul Gaynor’s view that it would probably be better for the industry if the PTC were not extended?

MR. STORCH: What would be best for the industry in my personal opinion is a five- or 10-year extension of the PTC that ratably phases out to zero at the end of this period so that people can plan. A one-year extension in a lame duck session of Congress in December is almost worthless except for a handful of projects. The industry is dead in the water for now after 2012 and will likely stay dormant for at least a couple of years without some kind of PTC extension. Maybe there will be a couple projects that will benefit in the first quarter of 2013 because they failed to achieve commercial operation at the end of this year. Maybe a few projects with long-term power contracts will be able to make something happen, but a one-year extension would not bring back the turbine manufacturers’ operations to full scale.

Returns in the US Market

MR. MARTIN: Let the record show that when Mike Storch mentioned a one-year extension, Martin Mugica waved his hand dismissively.

Let me test a proposition. We had a large Spanish solar company come through our offices a few weeks ago that is keenly interested in Latin America and Africa for utility-scale solar development, but not so much in the United States. The company does not believe the returns justify large solar projects in the United States, even with a 30% investment tax credit. Bob Mancini and the rest of you who are moving some of your resources into solar, is the Spanish company right or, if not, what does it have wrong?

MR. MANCINI: I think the company is right. The Chinese panel manufacturers have a severe overcapacity problem and have been bidding into utility tenders as a way of finding outlets for their panels. This has pushed down returns to a point where developers are better off looking at other markets. Capital finds the market with the best balance of risk to reward. However, the issue in many emerging markets is lack of infrastructure to support development. There are better opportunities still in the solar sector in places like Germany, parts of India and probably Brazil than in places like Africa where there is not the infrastructure to support utility-scale transmission.

MR. MARTIN: Does anybody else disagree with the Spanish assessment?

MR. GAYNOR: We are focused on markets that are short on renewable electricity. The New England states, California and Hawaii all places that are desperately short. For example, there is only one wind farm in Vermont.

MR. MARTIN: It is a First Wind project. Can we see it from here?

MR. GAYNOR: You would have to get up on top of a mountain with binoculars. It took us six years to develop. The New England states have 750 megawatts of wind farms in operation or under construction, and they need to get to 4,000 to 5,000 megawatts by 2020. It is a great opportunity. There is a better ratio of risk to return here than some place south of the border.

MR. MARTIN: You are still bullish on those parts of the US that have high renewable portfolio targets that have not been met. Martin Mugica?

MR. MUGICA: I got a lot push back from our parent company when I started promoting two solar projects in 2010 because of the experience with solar in Spain. It took a lot of time to convince our parent that these were good projects with sound long-term power contracts. We are looking to do more solar in the US. Our experience in other countries like Brazil and Mexico has also been good. The problem in Mexico is that you have in almost all the cases just one customer: the Comisión Federal de Electricidad. Brazil is a very complicated country politically. You really need to have good partners and contacts to be successful and, then, you know how it is currently in Europe. We came to the United States in 2006. Right now we have 5,500 megawatts of operating projects. I do not see any other country in the world that can give you that kind of opportunity.

MR. MARTIN: So there is an alternative Spanish view that is still bullish on the US market.

Bob Mancini, let’s drill down into something that you said. Solar panel manufacturers are competing with developers in utility solicitations to supply electricity. Some manufacturers have acquired smaller solar developers so that they are vertically integrated. Is this making it impossible for true developers to operate?

MR. MANCINI: It is making it difficult for those of us who are looking for reasonable returns to compete. It is not a level playing field. The Chinese panels are heavily subsidized. The tariffs that the US is moving to impose on Chinese-made solar cells are starting to have an effect. The Chinese are backing away from some projects that they were pursuing earlier. The Chinese panels will find other markets. The US margins are still too thin to reward us to take the risk. Part of the resolution will be to deploy some of the excess capacity in China. That would go a long way to change some of the current market dynamics.

MR. MARTIN: Mike Storch, what are current rates of return for utility-scale solar projects?

MR. STORCH: Solar is generally at the low end of the range. We are seeing market returns in the 7% range, perhaps a little better, but not much. Returns for wind projects are generally 8 1/2% to 10% except in especially competitive markets. These are unleveraged after-tax returns assuming tax subsidies.

MR. MUGICA: I think you could get a little higher return for utility-scale solar.

MR. MANCINI: Most bidders looking to buy someone else’s project look over a two-year period. They see that equipment costs fell X% in the last two years and generating efficiency increased Y%, and they extrapolate from that to where they think the market will be in two more years when the project is likely to be built. You have to take a leap of faith to believe that scale economies will continue to be achieved at the same rate.

MR. MARTIN: Sticking with rates of return, a developer can earn about 7% to build a solar project. What is his blended cost of capital to build the project? If it is higher than 7%, isn’t that the story right there? Does capital cost more than what one can earn from using the money?

MR. MANCINI: It does not make any sense currently to build new projects as far as we can see.

Business Strategies

MR. MARTIN: What types of questions will you be discussing in the next Enel strategy session?

MR. STORCH: Martin Mugica will be able to relate to this. What is happening in Europe has a huge impact, and it is hard for a European company not to have its conduct be governed to a large extent by the current climate in Europe. Europeans are experiencing things they never had to deal with before — for example, 25% or higher unemployment for people under 30 years old in places like Spain, Italy and Greece — and it creates a mindset that is not exactly geared toward entrepreneurial thinking. You have to get past that first. Then the next issue is where in the world are there opportunities for growth. There is a lot of focus on the next countries that make sense. Our parent company has operations in about 40 countries. Enel Green Power is active in 22. We try to add about two countries a year to our activities. There is a lot of focus on where we think we can capitalize on relationships, our expertise or particular opportunities that may be a little ahead of the market.

MR. MARTIN: Your own focus, though, is all of North America or just the United States?

MR. STORCH: Just the US and Canada.

MR. MARTIN: So what does the US team discuss when it gets together every two weeks to discuss strategy?

MR. STORCH: We recently had a team building event. It has absolutely nothing to do with your question. (Laughter.) Last Friday, I joined a group of 17 of my peers and walked barefoot over hot coals.

MR. MARTIN: This is to replicate conditions in the US market? (Laughter.)

MR. STORCH: Like the rest of the team, I survived. We believe that North America remains an area with real opportunities. Really large projects get done here. You have so many potential offtakers for electricity among the investor-owned utilities, municipal utilities, electric cooperatives and federal marketing entities.

I spend a lot of time explaining to Europeans that the United States is one country, but it is as fragmented as Europe as far as electricity markets are concerned. There are a dozen transmission regions, and you have to look at each in a very different way. What is the average price of electricity in the United States? Most people in this room would say the question is pretty silly. Too many people in Europe do not understand why.

MR. MARTIN: A former CEO of your company once told me that the United States is too chaotic, which was an interesting comment from the CEO of a company based in Italy, but he is right. It is 51 different regulatory regimes if you count the states and District of Columbia, with federal rules superimposed on top.

MR. STORCH: People generally like to keep things simple, but when you start talking about the United States and what it takes to do a project, even the simplest project is incredibly complicated. When we explain our projects to people in Europe, we start with the most predictable part: there are contracted revenues. It is hard to compare this approach to the simpler feed-in tariffs in Europe, but it has become clear lately that the tariffs carry political risk as governments across Europe scale them back. A little complexity is now tolerable for opportunity.

MR. STORCH: Paul Gaynor, when you strategize, is it as simple as asking in which states with high RPS targets you can secure a power contract? Is that all it comes down to?

MR. GAYNOR: Pretty much. Our business is to track where the RFPs are being issued. In the next nine months or so, utilities with obligations under renewable portfolio standards in the parts of the United States where we are most active will probably issue 10 RFPs. So the business model is actually quite simple. We don’t have to walk on any hot coals, other than at our board meetings.

MR. STORCH: I highly recommend it. (Laughter.)

MR. GAYNOR: The other place where we are focused is on acquisitions outside our existing markets for projects that are trying to do things that are complicated and hard and where there is potential upside.

MR. MARTIN: Martin Mugica, what is on Iberdrola’s strategic plan?

MR. MUGICA: There are three items. One is to improve operations, so we are working hard to increase production, reduce expenses and try to figure out ways to generate more revenue from our existing assets. That is our primary focus because we do not have big investment plans in the near future.

Next, we are trying to optimize our portfolio. We are looking at the geographic distribution of our assets and asking whether we might do better by redeploying assets, to the extent one can, in areas where markets are more likely to grow.

Finally, we are trying to reduce our merchant exposure by signing more long-term power contracts.

MR. MARTIN: Paul Gaynor, wind turbine suppliers are suffering from too much manufacturing capacity in relation to demand for new turbines. Are you being offered good deals by turbine suppliers?

MR. GAYNOR: Absolutely. Six months ago, we asked one manufacturer whether it would give us discounted pricing on turbines because of the risk that Congress will fail to extend production tax credits for wind farms and the answer was, yes, as long as we would pay full price if the PTC is extended. We said we are not sure that makes sense since we are taking the risk, we are building the project, and you will be able to keep your factories going.

Today, the tone of the conversation is very different. Now turbine manufacturers are talking about numbers that are staggering, less than $1,000 per installed kilowatt, regardless of whether there is a PTC. In our markets, pricing like that could make sense, so we are absolutely trying to take advantage of it.

Raising Capital

MR. MARTIN: Let’s talk about the difficulty of raising capital. Martin Mugica, you are backed by a Spanish parent. We read about the economic troubles in Spain. Mike Storch, you are backed by an Italian parent. We watch as the Italian government tries to stabilize the economy in the face of demands by the European Union for more austerity. Paul Gaynor, your company has had to rely on expensive private equity and your wits. Bob Mancini, your company is using Goldman Sachs money. How easy is it for any of you in this market to raise risk capital?

MR. GAYNOR: It is hard. We have raised more than
$6 billion in the last five or six years, so we are good at it, but we don’t have a parent company on whom we can rely, so it all has to come from within and on the backs of our projects.

We have had two recent notable successes. We did a high-yield bond offering last year, the first one in the renewable energy business. The bonds were issued at 10.25% interest. We are using the money raised as equity in our 2011 and 2012 projects. Raising 10% equity is pretty good.

Then we closed on a joint venture transaction with Emera, a utility holding company based in Nova Scotia, where we essentially sold 49% of our operating assets in the northeast. They come to about 400 megawatts. Emera has an ongoing obligation to provide 49% of the equity at financial closing on our new 1,200 megawatts in the northeast at a pre-determined cost of capital, which is at a competitive rate.

These two transactions have put us in a good position in the northeast. Companies like ours have to fight and claw to create some liquidity and build value.

MR. MARTIN: Bob Mancini, you are pivoting from solar into natural gas-fired power plants. Goldman Sachs is willing to keep investing freely in that sector?

MR. MANCINI: Even though we are owned by Goldman Sachs, it is probably the hardest place to tap for capital.

MR. MARTIN: Equity is always the most expensive capital no matter who is supplying it.

MR. MANCINI: Our equity funding is largely coming from Goldman Sach’s balance sheet, but our projects have to be structured to use as much project financing as each project can support from external sources. Therefore, it is imperative for us to have a long-term power contract for each project from a utility with a good credit rating. Projects with creditworthy PPA are no trouble to finance.

MR. MARTIN: Are you finding the utilities more receptive to buying power long term from gas-fired plants than they are from wind or solar projects?

MR. MANCINI: It depends on the part of the country. California is a good place to be. However, there has been a general shortening of PPA terms. Long term is no longer 20 years. Long term now is 10 years.

Sage Advice

MR. MARTIN: We have just a few minutes remaining. Let’s try to sum up. This is a challenging time. It is a transition year for wind, but perhaps less of one for solar. What would you tell a CEO in this sector is the right survival strategy?

MR. STORCH: With adversity comes opportunity. Right now I believe the opportunity is extraordinary. For example, let me put in a plug in for something called “net zero”, which is very important for the renewable energy business. Net zero is a way to piggyback on a peaker, where two projects, a peaking power plant and a renewable energy facility, use the same interconnection rights and share them in a way where their combined output at any point in time never exceeds the interconnection capacity, but the combined installed nameplate capacity greatly exceeds what the interconnection allows for. An example would be a 400-megawatt interconnection with 600 megawatts of generation. It might be a peaker and a wind farm. The opportunity is for overbuilding renewables against a smaller interconnection site or for combining renewables. It is something that all of us should be pushing the Federal Energy Regulatory Commission and regional transmission organizations to allow.

MR. MANCINI: Diversification is key because, as one market ebbs, the other flows, and that is what we have been trying to take advantage of in our own portfolio. I agree with Mike Storch that there is enormous opportunity over the next five to 10 years. Reserve margins will shrink with economic growth, and there will be a need for additional capacity. We will need a lot of peakers to fill in the gaps in electricity supply in markets where wind and solar supply a large share of total electricity.

MR. MARTIN: Renewable energy developers have done very well in a market with low load growth. Think of how well they could do if there was actually growing demand for the product. Paul Gaynor?

MR. GAYNOR: Fasten your seat belts, get your costs down, and try to become self funding. We have finally crossed the Rubicon and no longer have to go outside to find money to fund development. It is a great place to be. On the capital raising side, I would go down every path you possibly can — any kind of crazy idea that bankers or lawyers bring you — pursue it because it might just work out for you.

MR. MUGICA: I think it depends on what type of company you are. If you are a small developer, it is all about survival. Believe me, you have to survive because there will opportunities in the future, but it will be really hard to survive in this environment if things do not change. If you are a big company, then you have to manage your portfolio. You have to start trying to get good assets, dispose of other assets, look for synergies and improve your position in the right markets. Try to extract the maximum value for your existing assets by better integrating your facilities with the grid, creating value-added products for your customers and optimizing your capital structure.