Saturday, February 20, 2016

Wind Energy Economics - Truth v Fiction

Subtitle:  Buffett is No Idiot - Wind Requires Tax Credits

Some may recall that SLB has articles from time to time on wind energy, and a work-in-progress is a series  titled Truth About Wind Power. (see link)  I recently came across yet another article on wind economics, this one attacking the wind industry on several fronts.   I am constantly amazed, and dismayed, at the level of bad data, bad analysis, improper
 manipulations, and simply wrong conclusions stated in those articles.   This particular article (not singling this one out, as there are literally dozens of similar articles published in various places) appeared about a year ago (May, 2015) on Dr. Judith Curry's blog ClimateEtc  (CE).  see link to CE article.  

The CE authors had quite a number of wrong statements, but this article addresses only the effect of wind subsidy on the investment decision to build wind turbines.  The CE authors attack Warren Buffett, the well-known billionaire investor and CEO of Berkshire Hathaway Corporation (NYSE: BRK.A, and BRK.B).  Buffett said, 

 "I will do anything that is basically covered by the law to reduce Berkshire's tax rate," Buffet told an audience in Omaha, Nebraska recently. "For example, on wind energy, we get a tax credit if we build a lot of wind farms. That's the only reason to build them. They don't make sense without the tax credit." -- US News and World Report, 5/12/2014, "Big Wind's Bogus Subsidies"  

CE authors then state, see quote:

"Buffet gets a total PTC (production tax credit) of $31.5/MWh from both federal and Iowa taxpayers. YE2014, BH’s MidAmerican Energy, had 2953 MW of Iowa wind capacity. Warren Buffet wind farms  are receiving $253 million of annual tax credit from Iowa wind generation on an investment of $5.6 billion (2953 MW * 0.31CF * 8766 hr/year *$31.5/MWh). BH’s effective tax rate last year was 31%. Those wind credits are equivalent to earning (253/0.31) $816 million on his $5.6 billion wind investment—a 15% return before any operating profit from selling electricity. That is a good deal for the Nebraska billionaire, but not for the rest of us."  -- (Note, BH is Berkshire Hathaway; MidAmerican Energy is the electric utility owned by BH; CF is wind capacity factor, annualized output as percent of nameplate capacity) 

Where CE authors are very, very wrong is the last bit: "Those wind credits are equivalent to earning (253/0.31) $816 million on his $5.6 billion wind investment—a 15% return before any operating profit from selling electricity."  

I won't quibble about the installed MW capacity (2953 MW) nor the $5.6 billion investment (it's probably a lot more, being built over many years when sizes were smaller and unit costs were higher.)   The point is made without using more accurate figures.  

Also, I won't quibble about the wrong value CE authors used for the PTC, at $31.5 / MWh combined federal and state. (it is actually $33, with 23 from federal and 10 from state).   Again, it makes zero difference in how wrong they are about the return on investment, and how wind energy makes "15 percent return."

Also, I won't point out that CE authors apply the $10 / MWh for Iowa state tax credit against the entire 2953 MW of installed capacity, when the state clearly limits the credit to:  "For wind energy facilities, the maximum total eligibility is 363 MW." -- (Iowa Utilities Board)

Again, the CE authors get almost nothing right.  Next, they cannot compute economics correctly, either. 

CE authors take the (wrong value) of $253 million per year of tax credits, then divide this by 0.31 effective corporate tax rate to obtain a fictional "earnings" number of $816 million per year.   At no time does the wind energy asset bring in $816 million from tax credits.   What actually happens is the wind assets bring in revenue from a Power Purchase Agreement (PPA), plus tax credits for eligible amounts.   But, continuing along the fictional return on investment calculation put forth by the CE authors:

Investment is $5,600 million. 
Revenue/year is $253 million.   
The simple table below shows the year of operation, the investment in year "0" and subsequent annual revenue streams, in $millions.    Note that only 10 years of revenues is allowed, as the PTC is only valid for 10 years.   

Yr    $ amount
--    ------------
0    (5600)
1      253
2      253
3      253
4      253
5      253
6      253
7      253 
8      253 
9      253
10    253

A cursory examination shows that the revenues do not sum to the investment, achieving something barely more than one-half the investment after 10 years ($2,530 vs $5,600).   Under financial and accounting practices, such an investment has a negative return ( the DCF ROI or IRR is negative 12 percent, not at all the plus 15 percent as claimed).

However, the investment actually has revenue from a PPA (as stated earlier) plus any tax credits.   Recent data shows PPAs are approximately 3.0 cents per kWh ($30 per MWh) in the Great Plains where Iowa sits, although a few years ago PPAs were double that.   The simple table below shows the first ten years for a combined PPA of $30 and PTC of $24, then years 11-20 for PPA of $30 only.   Note, the $24 PTC is derived from $23 at full 2953 MW plus $10 for the limit of 363 MW per Iowa law. 

Yr    $ amount
--    ------------
0    (5600)
1        434
2        434
3        434
4        434
5        434
6        434
7        434
8        434
9        434
10      434
11      241
12      241
13      241
14      241
15      241
16      241
17      241 
18      241 
19      241
20      241

Under financial and accounting practices, the wind investment has a slightly positive return ( the DCF ROI or IRR is positive 2.1 percent).  Note, however, that these annual revenues are actually sales $, and must be reduced by the amount of operating expenses such as labor, maintenance, parts, property taxes, insurance, and other costs. ( UPDATE: 2/27/2016 - recent operating and maintenance costs are approximately $10 per MWh, per US DOE "2014 Wind Technologies Market Report," Figure 43. -- end update)

It is clear, then, why Buffett says the wind farms make zero sense without the tax credits.  The investment barely breaks even when tax credits are applied.   Without the tax credits, the ROI above is slightly negative at minus 3.3 percent.  

How, then, does a savvy investor like Buffett make money in wind farms?  The answer lies in the full financial analysis that involves fast depreciation of the investment, plus using debt financing for a portion of the investment.  

It is also clear that the CE authors are very much biased against wind energy systems, as they completely missed the mark in the return on investment.  

(Note: for those who doubt these numbers, simply copy and paste the data tables above into a spreadsheet that calculates IRR, such as Excel (TM).  )  

Roger E. Sowell, Esq. 
Marina del Rey, California
Copyright © 2016 by Roger Sowell, all rights reserved

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