Hawaii’: Renewables Paradise?

Hawaii’: Renewables Paradise?

October 10, 2013

Hawaii has ambitious renewable energy and clean infrastructure goals, including a goal of generating at least 40% of its electricity from renewable energy and at least 70% from clean energy by 2030. This suggests plenty of opportunity for project developers, but there are unique challenges in Hawaii.

A panel of experienced developers talked about the Hawaiian market at a conference in Honolulu in September. The panelists are Hanson Wood, manager of development at EDF Renewable Energy, Joseph Rowley, vice president for power project development at Sempra US Gas & Power, Drew Bradley, Hawaii regional manager at REC Solar, William Kucharski, director of Pacific region renewable energy for AECOM, and Evelyn Lim, a Chadbourne project finance partner in Los Angeles. The moderator is Megan Strand, a Hawaii native who is with Chadbourne in Washington.

MS. STRAND: Hawaii has very ambitious goals for renewable energy. What should anyone know who is new to the Hawaii market about developing or financing a project there?

Special Challenges

MS. LIM: There are unique challenges. One is geographic isolation, which can make for challenging logistical issues to arrange for and coordinate deliveries of equipment. The high and low tides vary from one island to the next. Deliveries must be scheduled at high tide so that the ship can reach port.

Another challenge is curtailment. Utilities are responsible for maintaining a safe and reliable system. It is hard to maintain a reliable system if your electricity source disappears as soon as the wind dies. Unless there is some sort of smoothing aspect to it, it is really hard for the utilities to integrate such resources. Consequently, utilities are requiring developers of renewable energy projects to include energy storage in their proposals.

Another challenge is community relations. People here are more protective of the view, and you get into some interesting conversations with people who want to achieve energy independence but also preserve the natural beauty of the islands.

Moving to the plus side of the ledger, electricity prices are higher than on the mainland.

MR. ROWLEY: On the islands, space is at a premium, and the space is valuable economically, ecologically and culturally. On the mainland, we can afford to avoid sensitive areas, but it is much more difficult to do on islands. It requires a much more intensive look at siting to reduce the impact on cultural and biological resources.

There is a strong desire to restore native habitats on the islands. We have gone to great expense to restore the native habitat even where it does not exist today. That is an additional cost to an island project that you would probably not have on the mainland.

The grid is a huge issue on the islands. When you have an island grid, you cannot lean on your neighbors. The grids are not interconnected, so each island has to manage its own frequency. To do that every moment of every day is a huge challenge. Intermittent resources present a challenge. For example, at our Auwahi wind project, we have 12 megawatts of battery storage to act as a shock absorber between the project and the grid. A project on the mainland would not have to have that.

MR. WOOD: Government policies and incentives are an important part of any renewable energy developer’s life. Trying to pin down the policy in Hawaii has been a major challenge. Anyone developing projects here has to take a long view. It is not a place where you can come in and get two or three projects done six months from now.

MS. STRAND: Does project development take longer in Hawaii than on the mainland?

MR. WOOD: It is less predictable when you will have the opportunity to market your project. Permitting a wind project in Hawaii is probably the most difficult place you could imagine. Add on top of that the uncertainty of knowing that there will be a market for the output in theory, but you do not know when. Once the door opens to negotiating a power contract, you can be sure that there will be challenges and local opposition.

MR. KUCHARSKI: Another issue is the small scale of projects. Because the islands are not interconnected, you are dealing with lots of small loads.

MS. STRAND: What advice do you have for someone who is new to Hawaii about the policy process?

MR. WOOD: People are lured into the market because of the high energy rates and the abundant resources. Developers think “Oh yeah, development’s difficult, but we have done it before and we can do it again.” It does not work here the way it does on the mainland. You have to plan to build a presence that can be sustained over a very long period of time.

You cannot come into Hawaii thinking you are going to show results in six months or a year. Your management will have to understand that this is a longer-term play.

MS. STRAND: Is the extended development process as much a problem with distributed solar installations on the various islands?

MR. BRADLEY: The main challenge with distributed solar is uncertainty about the incentive. Every year we get the legislature together and figure out what the state incentive will be that year. The Hawaii Department of Taxation steps in and comes up with a temporary administrative rule that completely changes the returns. There are a lot of wild cards.

It is good that the deals can be fatter here. They start with what appears to be a high rate of return, but by the time you take into consideration the additional cost, the premium of doing business in Hawaii and the premiums for labor and land, the soft costs and the friction on the deals, the high return can disappear quickly. Be prepared to lose some hair.

Construction Contractors

MS. STRAND: Is the construction work contracted out locally or do you work mainly with companies on the mainland?

MR. BRADLEY: We are a contractor so we build the majority of our projects. The challenge is finding enough electrical journeymen, who are always in short supply here because of the lack of reciprocity for electricians licensed in other states. There are never enough electrical journeymen. It is easy enough to find mechanical people and workmen with low-level skills. Anybody can look on Craigslist and see that every single contractor is looking for electricians right now.

Obviously if you cannot find them here, the last ditch effort is to fly them in. Nobody wants to fly in electricians because they cost more, and you are paying not only a per diem rate, but also putting them up in hotels and paying for rental cars and all of the additional costs.

MR. WOOD: We used REC, which has one of the largest presences in the Hawaiian Islands, but it also has a large presence on the mainland. We ran an informal solicitation to look at both mainland and local companies. We had a high-profile client, Safeway, which has 19 solar facilities already in Hawaii and got into the game in 2007. One of our projects went over the delivery deadline, so it was great to have a company like REC that can expedite by pulling in reinforcements from other locations.

MS. LIM: The utility-scale developers work with both national and local companies. The lenders and tax equity investors usually want to see a large company that has done a number of projects so as to reduce the execution risk. The national companies will often hire local subcontractors to do a lot of the work.

MR. ROWLEY: An important distinction is that a utility-scale project on the islands is smaller than a utility-scale project on the mainland. For example, our 21-megawatt Auwahi wind project is a good sized project anywhere, but it is not really large enough to finance efficiently. We used our own internal capital to fund the project. Unless one has enough projects to aggregate, the threshold for where you can get project financing is not readily crossed here. Financing utility-scale projects in Hawaii is an issue because the projects are not large enough to finance efficiently.

Another factor that contributes to the small project size is that finding enough land in one place to do a large project is really not practical. In theory, if there were two or three smaller projects that were done around the same time and had similar attributes, then they might be aggregated and financed, but that is not a strategy that we are pursuing.

MS. LIM: It differs from developer to developer. A developer with a large balance sheet can afford to use its own capital. It will have a lower cost of capital than a smaller developer who might be backed by private equity or venture capital and whose cost of capital is high enough to make project financing a necessity. As long as you are developing a good project, you should be able to get it financed. Developing a good project means identifying the risks and addressing each. Risks do not have to be eliminated. If they can be quantified and mitigated, then the project should be possible to finance. You need to get your lenders or tax equity investors comfortable that you are aware of what might happen and that you have a plan in place to address issues that come up during development, during construction or during operations.

MR. ROWLEY: What I was talking about is not whether the project is financeable, because I agree that the financeability of a project is all about the quality of the project, and that is not really a function so much of size. What I was talking about was efficient financing for a project because there is a transaction cost of financing that is substantial. The larger the project, the more efficiently it can be financed.

MR. KUCHARSKI: There is also the issue of having confidence the project can be completed on the time schedule and within the budget that you agreed with the financier.

MS. LIM: That is particularly important with the deadline to have started construction of wind farms and some other projects this year to qualify for tax credits, and solar facilities need to be in operation by December 2016 to qualify. You might want a contractor who is large enough to be able to pay damages if the deadline is missed.

MS. STRAND: Do technologies that are considered proven on the mainland have to prove themselves separately in Hawaii before they can be financed?

MR. KUCHARSKI: Not usually, but there are some special technologies in Hawaii that still have a way to go before they are fully financeable. An example is ocean thermal energy conversion or OTEC. I think OTEC is a great technology. It has been proven on a pilot scale, but still needs to be proven on a large scale.

Small Loads

MS. STRAND: The state is talking about an undersea cable to link the islands. How important is the cable to meeting the 40% renewable energy target?

MR. KUCHARSKI: Having 500 megawatts of new power on various islands is not going to help anyone if it cannot be exported to Oahu. Eighty five percent of the population is on Oahu. If you cannot export power from other islands to Oahu, then it will be very difficult to reach the 40% renewable energy target.

Even more fundamentally, say 9,000 people are on an island. The power needs to be generated where it can be most inexpensively produced and exported to where there is a load so that you can get to base-load levels, even if it is a variable power source. The only way to reach scale is to have interconnections among the islands.

MR. BRADLEY: There are only 1,200 megawatts of load on Oahu, 200 megawatts on Maui, roughly 200 megawatts on the big island of Hawaii and just a few megawatts on each of the other islands. Two hundred megawatts is not insubstantial. There is a substantial grid on Maui. There is a substantial grid on the big island, and likewise on Oahu. Obviously, the bigger the grid, the more easily some of the issues that we have talked about can be managed. When you have a larger aggregation of load and a larger selection of generating resources, the bigger the pot that you mix together and the more effectively it can be done. So the question is at what point does it make sense to integrate islands in order to achieve scale? What we are seeing is a very thoughtful approach in that direction.

MS. STRAND: Is it both an issue of integrating between islands and also upgrading the existing grids on individual islands?

MR. BRADLEY: As long as the islands operate independently, then it is just that island and what degree of energy storage needs to be incorporated in order to deal with the intermittency of new wind and solar. The same issues still exist with a larger interconnected grid, but things tend to smooth out when you put more pieces together.

MS. STRAND: Will all future utility-scale solar and wind projects have to incorporate storage?

MR. ROWLEY: No, but I think it makes sense for the first projects. This is a very different world from just a few years ago where utilities had complete control over generation and could readily match generation and load for each moment of the day.

In these initial projects, it makes sense for the generation resource to bring along energy storage as a form of shock absorber. As the grid operators become more experienced with intermittent generation, then I think that we will see a transition toward the grid operator looking at it from an aggregated perspective rather than looking at individual generators. The needs for ancillary services and storage are less in the aggregate than when you look at a single project. As the utilities gain more experience, they will want to place ancillary service sources and energy storage in places that most advantage the grid from an aggregate perspective.

One of the more thoughtful approaches we see as Hawaii gains experience is a strong emphasis on economics. It is one thing to have a certain percentage of renewable energy, but it is quite another to say let’s meet that objective, but at a cost that makes sense. One of the benchmarks on which Hawaii is focused is to have our renewable energy be cheaper than displaced oil. Putting storage where it is most economic to place storage, rather than in smaller units at each project site, would aid in meeting that objective on economics.

MS. LIM: I agree with Joe Rowley, but how do you see the widespread adoption of residential rooftop solar affecting decisions about storage?

MR. BRADLEY: If we are going to stick with the battery concept, it would be nice if the utility could collect the cost from ratepayers, but right now it looks like the developer is going to have to pay for the storage on a project-by-project basis. Turning to distributed generation, I see a big market for storage because we have a 100-kilowatt cap for net metering, and we have a bunch of commercial businesses that do not have a seven-day-a-week load. There is potentially a healthy market for batteries essentially to take a net metering project and overstuff it with capacity, with more modules, and then use the batteries to shift electricity into the evening hours.

We are involved in only one big utility-scale project currently with Kauai Island Utility Cooperative. It is 12 megawatts. The utility decided the project needs six megawatts worth of batteries, and it will pay for them. So in its mind, it is using a two-to-one ratio of PV to batteries. That is pretty conservative, but it wants to ensure that it can maintain grid stability and it is willing to pay whatever six megawatts worth of batteries costs for grid stability.

MR. WOOD: The economies of scale change dramatically when you go from 50 kilowatts to 100 kilowatts to five megawatts to 20 megawatts. Energy storage should be a tool for the grid to identify. The utility should identify weak places in the grid and strengthen them through ancillary services. As market penetration of distributed generation increases, there will have to be that support system even though the grid may need to be upgraded itself. It will probably end up with some form of band-aid, especially if there is rapid growth in distributed generation.

Distributed Solar

MS. STRAND: Drew Bradley, you mentioned the temporary rules the Department of Taxation issued for the state tax credit for distributed solar. Have they had a chilling effect on new distributed solar development, and do you think the state legislature will have more to say on this subject in the upcoming session?

MR. BRADLEY: I sure hope so. They do not affect distributed generation projects that cost less than $1.43 million. If you were working on projects that were bigger than that, back in the day, you would just throw more inverters at it and treat the project as multiple systems, each of which qualifies for up to a $500,000 tax credit.

Let’s say you do not have any state tax liability and you are taking the 24.5% refundable tax credit and, all of a sudden, you move from a $1.43 million system up to a 1-megawatt system at $3 million. Your state tax credit as a percentage of the project cost went from 24.5% down to about 10%. You lost 14 points with that one, with the Department of Taxation essentially creating law rather than interpreting it. That’s what happened on the bigger systems, so it made it much harder to get bigger projects to pencil out. It definitely chilled the market.

MS. STRAND: Did you see an effect on residential projects?

MR. BRADLEY: Just from 300 kilowatts up to one megawatt. The closer you get up to one megawatt, the lower your return because you are getting a smaller and smaller state tax credit as a percentage of project cost. Every year the residential market is uncertain what will happen at the turn of the calendar on January 1. That actually helps the residential solar companies because potential customers never know what they will receive the following year. Therefore, there is an incentive to act now.

The uncertainty is less helpful to commercial solar developers. They are usually trying to do a two- or three-year project, and they cannot see what the incentives will be even the following year.

MS. STRAND: To what extent are the larger commercial projects driven by the tax credit, whether state or federal?

MR. BRADLEY: As long as we have a 30% federal tax credit and something in the neighborhood of a 20% or 25% refundable state credit, then that works. The projects here are very attractive. Financiers from the mainland call us constantly looking for projects to finance.

Other Opportunities

MS. STRAND: What technologies do you believe Hawaii will have to tap to reach the 40% renewable energy target? We touched on OTEC, which is still in development phase. What else?

MR. KUCHARSKI: Biofuels. Hawaii has three crops a year, and some reasonably clean fuels can be produced to compete with refined petroleum. That is a growth area. The majority of imported fuel in Hawaii is going for transportation, not for utilities. Every plane that lands in Hawaii refuels and that fuel has to come from somewhere.

MS. STRAND: Are there any other technologies that appear promising?

MR. BRADLEY: You will not see wind farms built after this year if they have not qualified for federal tax credits by starting construction this year. Your bread-and-butter developments will more than likely come from distributed solar. Hawaii has major land use issues for greenfield development. Solar is well suited for brownfield-style development or even development in parking lots or on other land that can be put to dual use.

MR. WOOD: You can achieve scale in areas that are already developed. That is the ace up the sleeve on solar in my opinion.

MS. LIM: Offshore wind has many advantages, but one of the biggest challenges is the technology. It is hard to get banks to finance new technology, even if the technology has been proven in another country.

MS. STRAND: How about some parting advice? We all learn from our mistakes and by doing.

MR. ROWLEY: Have a long view.

MR. KUCHARSKI: My advice is similar. Don’t think in months.

MR. WOOD: My advice is for mainland developers who may be thinking of entering this market. If you have been active in the renewables sector and bidding into utility solicitations, particularly in California, you have seen how aggressively people have been bidding. In Hawaii, things will cost more than you think. You don’t know where your cost overruns are going to come from, but there will be cost overruns. Don’t be short-sighted and try to undersell your first deal and not deliver on it. Hawaii is a small community. Your reputation will get around pretty quickly. Sell the projects that you know you can do. Make sure that those projects are high-quality projects. Don’t rush in here and try to underbid because the strategy will backfire.

MS. LIM: Make sure that you are familiar with the local and state regulatory regimes. They can be a source of surprises and contribute to cost overruns.

MR. BRADLEY: Get beyond the initial up-front cost when shopping for a construction contractor. Look more at life-cycle costs and make sure that when you save a dime, it doesn’t cost you a dollar. Look at a company’s track record. Investigate what it has built. Actually look at it. Make sure the company has an O&M group that can take care of the project after it is built. Take that reference list and call every last customer. Find out what references are not on the reference sheet, find out why, then contact those companies, and dig a little bit deeper so that you’re not bending over to pick up a dime and really missing sight of the fact that it’s a 25- to 30-year project.