Coronavirus: Power sector outlook
This was expected to be a peak year in new capacity additions for wind and solar projects before the coronavirus. How has the outlook changed? Is work continuing on projects that are already under construction? Are new projects still able to secure financing? How are utilities faring? What issues are companies facing that will require a government response?
A group of power company CEOs discussed these and other subjects on a well-attended conference call on March 20. The CEOs are Michael Garland, CEO of Pattern Energy, Paul Gaynor, CEO of Longroad Energy, Miguel Prado, CEO of EDP Renewables North America, Jim Torgerson, CEO of Avangrid, a holding company for eight utilities in New England and upstate New York, Guy Vanderhaegen, CEO of Origis Energy, and Tom Werner, chairman and CEO of SunPower Corporation. The moderator is Keith Martin with Norton Rose Fulbright in Washington.
Effect on Revenue
MARTIN: Let’s start with how revenue into the power sector is being affected. In 2009, industrial demand for electricity in Europe dropped by around 14% on average. The early data out of Europe suggests the current drop in electricity demand is 15% year over year in Italy, 9% in France, 6% in the UK and 2.5% in Germany.
Jim Torgerson, I imagine that utilities in the US rust belt and in the oil patch will feel the drop most significantly. What are you expecting in New England and upstate New York?
TORGERSON: We have not seen much change yet, but we are expecting a slight decline. With everybody staying at home, the residential load will probably increase a bit. The good news is that all of our utilities have decoupling, so our revenue will remain flat regardless of what happens on load.
MARTIN: Not all states have decoupling. Explain what it is.
TORGERSON: Decoupling means that our revenue gets set based on our rate base. The public utility commissions figure out what revenue we should get in order to reach our allowed return. The revenue stays flat based on that calculation. Managing the operating expense is up to us. If our revenue is higher or lower in any particular year, then there is an adjustment where either we collect more or give back to the customers in the following year. We always get the same amount of revenue.
MARTIN: So there is an automatic adjustment. You do not have to wait for a rate case every two years.
MARTIN: Tom Werner, SunPower makes premium solar panels. Some are manufactured in Malaysia. Malaysia has ordered at least a two-week shutdown of factories. What effect do you expect from coronavirus on your revenue?
WERNER: The situation is dynamic. We produce in Malaysia, the Philippines and China. The shutdown in Malaysia has affected our operation. However, there is work being done to exempt semi-conductor and solar factories so that they can operate at some percentage of capacity. The Philippines similarly has stopped work, but we expect that will clear up in the next few weeks. China has been back on line for more than a month after an initial shutdown there. Things remain fluid. Our hope is that our operations will be back fully on line in due course. The shutdowns are buffered to the extent that we have sufficient inventory to buffer.
MARTIN: Have you had to send force majeure notices to anyone?
WERNER: The answer is complicated because we have suppliers, project finance relationships and customers. For supply, no. We are probably going to have to send some in the
MARTIN: The rest of you are independent generators. Many of your projects have long-term contracts to supply electricity. I imagine that projects with such contracts are more insulated from the effects on revenue but, Mike Garland, let’s start with you. How are independent generators affected on the revenue side?
GARLAND: In a couple of ways. First, about 10% to 15% of our revenues come from electricity sales in the spot market. Those will move up and down with stock market pricing. Second, power contracts have curtailment provisions. However, for the most part, we are not seeing any material changes in our revenues or production levels.
MARTIN: Do you expect that pattern to hold, even if the economic dislocation due to coronavirus stretches into July or August as President Trump suggested it might.
GARLAND: I expect that demand will drop. You hear numbers in Italy of eventual drops in electricity load of as much as 20% to 30%. Similar drops in demand in this country would affect spot prices, and power plants are also more likely to be curtailed. I think it will affect some of our revenues, but not in a huge way, at least not in the short run. If the dislocation lasts six months or more, then we could see a real effect. If things recover fairly quickly, then the effects will be pretty insignificant.
MARTIN: Paul Gaynor, where there is a revenue effect, what causes it?
GAYNOR: In liquid markets, electricity prices fall when demand drops. If you have a project with a significant merchant component in places like ERCOT or PJM, that is probably where you will see the most pain.
MARTIN: Miguel Prado, anything to add on revenue?
PRADO: We are starting to see prices declining as a result of the decrease in demand, especially in places like ERCOT where a lot of electricity goes to drive oil production. The electricity futures for this summer in ERCOT have already dropped from more than $100 a megawatt hour to close to $60. To the extent projects are selling on a merchant basis into the grid, there may be an impact.
The other way coronavirus can affect revenues is from delays in construction. We are already receiving force majeure notices. Some are on wind projects that we are building this year. Construction delays will delay when revenue starts to be received on these projects.
MARTIN: So two effects on revenue for independent generators. One is the effect on electricity prices for projects that are selling on a merchant basis into organized markets. The other is revenue will not start on schedule because the project is delayed. Mike Garland, what percentage of your revenue is merchant?
GARLAND: Ten to 15% on a gross basis.
MARTIN: Paul Gaynor, what percent?
GAYNOR: Probably less than 5%.
MARTIN: Miguel Prado, what percent?
PRADO: Less than 10%.
MARTIN: Guy Vanderhaegen, how is coronavirus affecting revenue for Origis Energy?
VANDERHAEGEN: The impact on our revenues is very limited. More than 95% of our revenues are contracted revenues under long-term power purchase agreements. We have very limited merchant exposure.
MARTIN: Mike Garland, you mentioned that one way revenue might diminish is if the projects are economically curtailed. Are you seeing any economic curtailment where utilities tell you to stop generating because they do not need the electricity?
GARLAND: Not at all. We actually have an interesting situation in Ontario. We were going to shut down one of our plants to do some maintenance and repairs. Ontario required that we not do that. It has in most of the PPAs a provision that allows it to curtail up to a modest amount of electricity without compensation. We have seen that right exercised over the last several years because electricity demand has been less than the supply, and Ontario has even gone so far as to curtail substantially more than the allowed curtailment through reimbursements. But, as of this morning, it had a demand of about 15,000 megawatts and 17,500 megawatts of supply, and there were no curtailments. Ontario has about a 17% reserve margin, which is very nice to have, but so far we have not seen significant curtailment under any of our contracts in the last few weeks.
MARTIN: Is anyone else seeing economic curtailments?
PRADO: The early data does not suggest an increase in curtailments as a result of the social distancing measures that have started this week. But it is important to note that generation from renewable sources across all markets has been low in the last few weeks. For example, in the Bay area, the hours with the largest declines in terms of demand coincided with the solar generation peak. This suggests that we may have economic curtailments in the next weeks if the situation persists.
MARTIN: In California.
GAYNOR: We have seen a little curtailment in Texas, but mainly from transmission outages and not from economics.
MARTIN: The transmission outages are just serendipitous. They have nothing to do with coronavirus, correct?
TORGERSON: They are due to maintenance.
MARTIN: Mike Garland, you said in Ontario that the utilities are not required to compensate the generator for economic curtailment. Is there any place in the US where that is also true?
GARLAND: Not under our contracts. [Laughter] We are not seeing much, and I would just emphasize that in Ontario, it is only a modest amount. Ontario can only curtail a couple hundred hours a year without reimbursement.
MARTIN: What happens in ERCOT or PJM? These are organized markets where some projects sell their power into the market for whatever the spot price is. As demand drops, I imagine it could lead to negative prices. Is anyone seeing negative prices at this point? [Silence]
MARTIN: I will take that as a no.
PRADO: We have not, but the situation is completely different. In ERCOT, we are talking about a renewables penetration of up to 60%. Negative prices have been particularly frequent in the South in the past due to transmission outages. Depending on the demand and on how the price of oil evolves in the future, we may see a lot more economic curtailment. So far, we have not seen it.
MARTIN: Negative prices mean you have to pay the grid to take the electricity. Most of renewables projects selling in organized markets on a merchant basis have a hedge to put a floor under the electricity price, but the more recent hedges do not cover negative prices. What happens in that case? I guess the generator just eats the loss and hopefully the negative prices do not persist.
GARLAND: Correct. You pray a lot.
TORGERSON: That is the hope.
GARLAND: We have one contract with negative pricing protection for the offtake.
Slowdown in Development?
MARTIN: Shifting gears, the economy is contracting across Asia, Europe, the United States and Canada. What effect is this having on the supply of development capital? The answer may be that everyone on this call is pretty well capitalized.
GAYNOR: We are definitely well capitalized, and our expectation is that we will have plenty of capital to get through a long drought cycle. I think the question is what happens to some of the smaller players and, as an industry, is there enough development capital?
My guess is that if this persists, there is probably not enough, which obviously creates some opportunities for everybody.
MARTIN: Opportunities to buy up rights to development assets because the smaller companies do not have the money to move them farther?
GARLAND: I think development work on a lot of projects will be delayed. That means having to manage your development capital differently.
The project finance markets are already starting to soften. Tax equity investors and even a number of bank lenders are starting to talk about “wait and see,” “see what the margins look like,” “we’ve seen the spreads blow out, the index come down,” which is fairly typical in any period of economic dislocation.
It is hard to tell today how that will affect project development. There are some potential customers for electricity who are pushing us to sign PPAs that are currently under negotiation for fear that the market will move against them on electricity prices. There are others who will want to wait to see where the market settles.
MARTIN: Are others seeing a slowdown in development?
WERNER: Permitting and interconnection have become more challenging. The counterparties are working from home in many cases in very dynamic situations, so that is affecting the pace of work on our projects, for sure.
MARTIN: Bloomberg reported this week that 30 power and energy companies are either drawing down existing loan facilities to ensure they have enough cash or are in talks with lenders about new loans. Do you see a move to build up cash?
TORGERSON: We are looking at expanding our existing loan facilities to make sure we have sufficient liquidity. It is more to meet liquidity requirements that the rating agencies impose than anything else. The commercial paper market pretty much dried up in the last couple weeks. We have been using our $2.5 billion revolving credit facilities and will probably arrange another facility so that we have more liquidity.
GARLAND: We have drawn quite a bit on our liquidity facilities because there was a period where there was some uncertainty about bank liquidity, and we are raising additional capital to build up a lot of cash so that we are in a position to execute on new opportunities.
MARTIN: Guy Vanderhaegen, the Tennessee Valley Authority asked for proposals this week to supply 200 megawatts of renewable energy to start at the end of 2023. Are you seeing any slowdown in RFPs?
VANDERHAEGEN: We have not seen a slowdown in RFPs yet, but we expect it to come. I think utilities have other priorities than launching RFPs in the next couple of weeks. At the same time, some utilities want us to rush to sign PPAs because they fear we might walk from the ongoing discussions. If RFPs are delayed and not canceled, then when the markets resume operating normally, there will be a large increase in the number of RFPs.
MARTIN: So perhaps there will be a surge in the fall.
VANDERHAEGEN: Yes, especially if the construction-start rules for solar projects remain unchanged. There will be a rush to sign PPAs as soon as the markets recover this year and at the beginning of next year.
GAYNOR: The big issue that will affect the pace of signing new contracts is whether something is included in the stimulus packages that are being discussed in Congress similar to what came out of the financial crisis in early 2009. Are there similar provisions, what do those provisions say and, importantly, do they require Treasury guidance to implement, and how long does that take?
If there are very clear and minor tweaks to the existing legislation on PTC and ITC qualification, then that is not likely to require guidance. That would be great and, as Guy Vanderhaegen said, things will pick right back up, but if there is any kind of fog in the air, then that will affect how quickly the industry can get back on its feet.
MARTIN: I assume almost everyone has received force majeure notices at this point from suppliers. Originally, they came from vendors with Chinese supply chains. Have the notices spread more widely to European and other Asian supply chains?
TORGERSON: Yes. We have had notices not only from solar suppliers, but also from wind suppliers. Even the EPC contractors are starting to notify us because they may not be able to get the people on construction sites.
PRADO: The wind industry supply chains are much closer to markets in Europe and North America, and they are being affected as production and logistics are curtailed.
US projects will have the additional pressure of qualifying for production tax credits, so it is becoming very important to address in a stimulus bill given the delays that we are starting to see. In the case of solar, the market is starting to come back, but in February, capacity utilization rates in China were 60% lower than normal capacity. We do not know yet the full impact related to that, but there will be one.
MARTIN: Most companies have told us they are responding to force majeure notices by simply acknowledging them and reserving their rights. Has anyone on this call taken a different approach?
If not, have you had to inform lenders or contract counterparties of these notices and, if so, how have they responded?
PRADO: We had to inform some of our customers about the force majeure notices from suppliers. They acknowledged receipt of the notices.
MARTIN: So just an acknowledgement. Are any of you experiencing actual delays in equipment deliveries or other supply-chain disruptions? It is one thing to receive a notice. It is another to have an actual delay.
GAYNOR: Not yet.
WERNER: There certainly were actual delays at the beginning in China. Exports of solar panels out of China were at about 60% of normal levels in February. While most of the problems have been sorted out, there was a definite slowdown, not only in February, but also in January.
MARTIN: Is anyone else experiencing actual delays on equipment deliveries?
TORGERSON: Not at this point.
GARLAND: We may be in an unusual position because most of the 10 projects we have under construction or about to start construction have 90% to 95% of the equipment already on site. It is the luck of the draw. The lucky timing on our construction projects means that we do not have any real exposure to supply-chain delays.
VANDERHAEGEN: We have not seen any material delays in the supply of equipment. Everything is more or less as planned.
MARTIN: With large parts of the US economy shutting down, are the construction crews still on the sites? Can the material reach the construction sites on the US highways?
WERNER: The logistics for us are still working. The challenge we have, of course, is that California is a huge market and the whole state under a shelter-in-place order. The interpretations of whether or not you can operate vary significantly. New Jersey and New York are in similar positions. The interpretations vary over whether you can work, and there is also the issue of whether the crews feel comfortable working. Things are situational and are evolving quickly. Mostly things are continuing.
GAYNOR: We have six projects with about 1,300 megawatts under construction or about to start construction. There are three solar projects and three wind projects. Knock on wood, but all of our sites are still going more or less full bore. I think the contractors are doing a good job of managing personnel on and off the sites while observing COVID-19 protocols.
As an industry, the big issue is whether job-site shutdowns will be required by state and local governments.
This is where the stimulus discussions in Congress would be really beneficial. If these shutdowns start to happen for COVID-19 reasons, then we are going to need flexibility interpreting deadlines to complete construction to qualify for tax credits.
MARTIN: I know owners like to observe work in progress. How do you manage that with travel increasingly restricted?
GARLAND: Our biggest fear is cross-border shut downs if the states start shutting their borders to people traveling from other states. We have a lot of labor that crosses state lines to get to job sites.
WERNER: As far as tracking construction progress, there has been a massive shift to everything online, including this panel discussion, and that includes tracking projects, permitting, designing projects, collaboration, and so forth. We were already making big investments in digital, and I think that shift has accelerated dramatically.
New Capacity Outlook
MARTIN: Next question. This was expected to be a peak year for new solar and wind capacity additions. How has the outlook changed?
GARLAND: Hopefully the worst that will happen is projects will be delayed. As Paul Gaynor said, we are all actively working to try to create some form of PTC and ITC extension for wind and solar.
In the meantime, we are pushing forward and trying to get our projects completed. As soon as the coronavirus surfaced, we tried to get our projects in a position where it would not have any effect on completing them this year. There will be some projects where the supply-chain logistics and other things, particularly on the solar side, will slow things down, causing construction to spill into future years.
GAYNOR: Depending upon how long this lasts, if you have a project in the chute and you are working toward a closing, like in the next month, my guess is that those deals will get done. There may be a change in pricing or fees, but my expectation is that things will hold together so long as there are no significant projected delays in construction.
It is a total toss up whether projects that are expected to enter the financing market in the second half of 2020 will get done. As I already said, it will come down to whether Congress steps in to help and how much clarity there is about how the relief provisions work.
MARTIN: A toss up because everything is back loaded, pushed into the last half of the year, or because of the uncertainty whether you will be able to meet deadlines at that point?
MARTIN: Miguel Prado, how has the outlook changed?
PRADO: No changes in the outlook thus far. Capacity additions before the summer are already in the last phases of construction. We have more than 1,000 megawatts under construction. What we may experience is some delays, as Mike Garland said, but the amount of construction activity is huge and, with any luck, it will still be a good year for this sector.
MARTIN: Jim Torgerson, how has the outlook changed?
TORGERSON: I don’t think it has yet. A lot of our projects are scheduled for the latter part of the year, so we very well could see some delays in getting them done. Then it becomes a matter of getting the IRS to extend the deadlines to complete projects to qualify for tax credits.
MARTIN: If there is no IRS relief, then what happens?
TORGERSON: As long as we can show continuous efforts were made to advance the projects, we should still be able to claim PTCs.
MARTIN: That’s if construction started because you incurred at least 5% of the project cost before the construction-start deadline. Many smaller developers started based on physical work. They don’t have the same option to buy more time.
TORGERSON: We started most of our projects under the 5% test.
MARTIN: Guy Vanderhaegen, has the outlook changed?
VANDERHAEGEN: A lot will depend on what happens in the next couple months. Right now, most projects seem on track, but of course if the situation deteriorates, then there will be delays.
I think you also have to distinguish among the different categories of solar, such as utility-scale, C&I and residential rooftop. The residential market is more exposed to difficulties with consumer markets shutting down, but for utility-scale, if things stay as they are or it does not get too much worse, people should be able to hit the targets.
MARTIN: Tom Werner, how has the outlook changed?
WERNER: It is early, but storm clouds are definitely on the horizon. As for the varying effects on residential, C&I and utility-scale, of course residential is heterogeneous and the impacts will vary by state. California has challenges. For C&I, different customers are responding differently. There are cases where customers have asked for projects to pause. I will say the origination activity in both residential and C&I is still good. As for utility-scale, if something good happens in Congress, it will have a direct impact and could reverse any potential carnage.
MARTIN: How could the origination activity be good if it relies on knocking on customer doors?
WERNER: We have moved a lot of that online. In residential, for example, you can design a solar system by typing in the address. For C&I, many people working under stay-at-home orders still want to get things done. We have daily tracking of indicators of demand. In residential solar, there has been some impact. In commercial, the data are actually quite good.
Availability of Financing
MARTIN: Has there been any change in the availability or cost of financing projects? Let’s go across the panel, starting with Mike Garland.
GARLAND: Yes. The base lending rate has come down, but we are seeing some widening of the spreads. The market for the most part is — I will use Paul Gaynor’s description — “uncertain” in that we are seeing people starting to back off a little bit in both the tax equity market and the lending market because they are unsure about availability of capital and the pricing. It is more about pricing. A lot of the banks are saying, “It will cost more to go forward with these projects,” and then some of them are starting to say, “Maybe the entire market is headed for a slowdown, so I would rather close on some good projects while I can.” There is general uncertainty all around.
GAYNOR: Again, I would answer in two parts. For projects that are in the chute and moving toward closing, we are not seeing any impact on pricing. But I agree with Mike Garland that for future projects, I expect credit spreads and fees to widen and increase.
PRADO: What we are seeing right now is an increase in the level of uncertainty, but it is too soon to assess what is the potential impact in the financial markets. We continue to move forward, but always with the caveat from our investors and banks that they are assessing the situation and, if something changes, they will let us know. For the moment, we are not seeing any of our investors back off, but the level of uncertainty has increased.
TORGERSON: We tend to self-finance or use our balance sheet to finance our projects. In cases where we use third-party tax equity for projects, I agree with the others there is growing uncertainty as to the commitments for closings in the last half of the year.
VANDERHAEGEN: I expect the biggest impact to be on the tax equity market. There is greater uncertainty. I expect some tax equity investors to withdraw from the market or for margins to increase.
WERNER: Same comment on tax equity. We expect a flight to quality, but no near-term impact. We are concerned about the back half of the year.
MARTIN: SunPower is partly publicly traded. The rest is owned by Total. What complications, if any, are created by falling share prices? Do they put pressure on debt-equity ratios and net worth requirements under parent guarantees?
WERNER: We are not there yet. The market is green today, which is good, and so we have not had an impact.
MARTIN: Jim Torgerson, have falling share prices had any effect on Avangrid?
TORGERSON: No, not really. They do not affect any of our credit ratios or anything like that, and we are not looking to raise equity.
MARTIN: How have asset valuations been affected? Does the M&A market continue to function in these circumstances because some sellers become desperate for cash or does a widening bid-ask spread mean it shuts down?
GAYNOR: We will know soon.
WERNER: It is a very dynamic situation. There are transactions moving to closing in the next few weeks, so decisions are being made, but we are not able yet to predict where this is going to go.
MARTIN: Last question. Starting with Mike Garland, what issues are you facing that will require a government response?
GARLAND: We are looking for a two-year extension of the deadline to complete projects to qualify for federal tax credits as well as for some direct relief on the value of the tax credits, without burdening the institutional tax equity market, by means of rebates or direct pay or some other method.
MARTIN: “Direct pay” is code, I think, for restoring the Treasury cash grant program?
GARLAND: Yes, effectively.
MARTIN: Paul Gaynor, what issues are you facing that require a government response? You have mentioned
GAYNOR: The other thing is some time relief on the need to take delivery of safe harbor equipment within 105 days after payment. We are fine at Longroad, but I think as an industry there are people who are probably going to experience delays in taking equipment for which they paid at the end of 2019 for delivery within 105 days after payment. And then, as Mike Garland said, some other relief around placed-in-service deadlines and propping up the tax equity market by temporarily restoring the cash grant program.
MARTIN: For the audience’s benefit, one of the ways to start construction before the deadline to qualify for tax credits was to make a payment just before the deadline and take delivery of equipment within 105 days after. Are you finding that the market is insisting on an actual delivery? The IRS regulations require only that delivery must be reasonably expected within that time period.
GAYNOR: It is enough to take title with that time period, but that is the issue.
MARTIN: Miguel Prado, what requires a government response at this point?
PRADO: I think the areas that Mike Garland and Paul Gaynor raised address most of the concerns in this sector. From our side, it is crucial to address delays to finish construction and an eventual situation of tax equity scarcity. Those are the two things that we need to address. The way that Mike and Paul described it is perfect.
MARTIN: This is a well-coordinated industry. Jim Torgerson, anything requiring a government response?
TORGERSON: It is the same answer.
MARTIN: Guy Vanderhaegen?
VANDERHAEGEN: I agree with what the others have said — measures around addressing delays and then also reintroducing the cash grants. Those measures would help a lot.
MARTIN: Tom Werner?
MR. WERNER: I completely agree. The clarity of voice of solar and wind has never been better.