Over the last few years, there has been much discussion about the role of tax credits in the wind industry and whether there should be offshore-specific incentives. With federal tax reform on Congress’ agenda, it is relevant to examine the implications of these policies.
The sunsetting of tax incentives is an ongoing concern for the wind industry as a whole, but it is particularly problematic for the nascent offshore wind sector. Offshore wind projects take multiple years to plan and permit. For example, it took nine years for the Cape Wind project to receive a favorable record of decision, which will ultimately allow the developer to begin construction of the 468 MW offshore wind project in Nantucket Sound.
As regulations become clearer, permitting requirements more streamlined and infrastructure plans more concrete, the time to plan and develop offshore wind projects will decrease. However, the development process will still be longer for offshore wind projects than for onshore wind projects. One reason for the long timeline is that existing state permits allow up to seven years from initial leasing to the start of electricity generation, due to the assessments, logistics and planning required for offshore projects.
The extension of the production tax credit (PTC) and the investment tax credit (ITC) – which allows projects to qualify for the PTC or ITC if they begin construction by Jan. 1, 2014 – is a step in the right direction, as is the passage of the Incentivizing Offshore Wind Power Act, which was reintroduced in February by Sens. Tom Carper, D-Del., and Susan Collins, R-Maine.
The legislation would provide a 30% ITC for the first 3 GW of U.S. offshore wind projects. Once awarded a tax credit, companies would have five years to install the offshore wind facility. Companies would not be able to receive other tax credits in addition to the offshore wind ITC.
In order to determine how tax credits would affect the offshore wind industry, financial models projected the capital and total costs for three hypothetical wind projects. Next, a cashflow was used to calculate the net present value (NPV) of the projects under different conditions. Then, a series of mathematical experiments was used with the cashflow to determine equations for the NPV from the hypothetical project scenarios.
The basic projects modeled include specific assumptions about configurations and components that were based on publicly available real-world data. Two hypothetical offshore wind farms were modeled for this analysis. Project 1 was a 500 MW project consisting of 5 MW turbines, and Project 2 was a 300 MW project containing 3 MW turbines. Each project featured monopile foundations. The hypothetical project sites were located six nautical miles offshore in 22.5 meters of water, and the projects’ expected lifetimes were 20 years. (Many of the projects currently planned in U.S. waters use other types of foundations. However, at the time of the model’s development, only monopile cost information was available.)
Although many factors influence project costs and returns, this analysis found that some factors far outweigh others. The equations that were generated to calculate the NPV for the sampled data contained five variables: capacity factor, average mean wind speed, electricity price, capital cost (CAPEX), and operations and maintenance expenses (OPEX).
Each variable was considered independent of the other four. Other factors, such as the size of the project, were considered fixed once these decisions were made. This was done in order to focus on the variables that create uncertainty – in other words, the factors that influence the financial outcome of the project but for which project decision-makers have little or no control. In markets where offshore wind projects can obtain a contract that sets a purchase price for the electricity, it is possible to remove the price uncertainty.
A third hypothetical project, Project 3, was structured in the same way as Project 1 but with a fixed electricity price of $0.155/kWh. This price was selected because it is halfway between the mean and high price values used in the rest of this analysis.
Estimating tax-credit implications
Three tax scenarios were modeled using the aforementioned process to generate sets of equations for the NPV for each project. The equations all had the same form but different coefficients for each variable.
The first scenario assumed that no wind-specific tax credits existed. Second, a PTC worth $0.022/kWh was assumed and taken for the first 10 years of electricity generation. The last scenario assumed an ITC of 30%, available to be claimed in the year that new equipment was placed in service. Specifically, this scenario allowed the developer to take this credit in the first year that the wind farm went into service and assumed that no other new equipment would be installed during the life of the project. The second and third scenarios were modeled after existing tax credits available to the wind industry.
Once the equations were generated, 1,000 combinations of the five significant variables were created using a random number generator for each project. Then the NPV for each set of variables was calculated, generating a set of 1,000 possible outcomes for each tax scenario. The chart below shows the range and means for each of the five input variables, where OPEX and CAPEX are shown in millions of dollars.
Of the 1,000 sample data combinations for Project 1, 26.9% generated a positive NPV without any tax credit. This percentage increased to 43.8% with a PTC and to 57.3% with an ITC. Electing the ITC allowed 30.4% more of the potential project outcomes to have a positive result, which is more than double the positive results that would occur with no credit claimed.
When the price was fixed at $0.155/kWh for Project 3, 44.1% of samples generated a positive NPV without a tax credit, 62.9% had a positive NPV with a PTC, and 79.2% had a positive NPV with an ITC. In the price-fixed scenario, claiming an ITC allowed 35.1% more positive outcomes than not claiming a tax credit at all.
For Project 2, 31.7% of outcomes were positive without a tax credit, 41.3% were positive with the PTC, and 54.2% were positive with the ITC. Choosing the ITC resulted in 22.5% more positive outcomes than having no credit. Table 2 shows a summary of the results from the entire analysis.
Nearly every outcome generated a higher NPV by opting for the ITC rather than the 10-year PTC. In fact, only seven of the 3,000 total samples – 1,000 per project – resulted in a higher NPV by taking the PTC, and the maximum higher NPV from the PTC was only $12.16 million higher. In contrast, choosing the ITC resulted in higher NPVs of up to $468.54 million above the return using the PTC. Choosing an ITC instead of a PTC resulted in an NPV that was an average of 14.2% higher.
These results clearly show that an ITC allows for the highest percentage of positive outcomes from a given offshore wind project. However, this process does not consider whether these hypothetical projects would be considered for planning and construction. Real-world projects would have a higher percentage of positive NPV results because of site selection and project-specific planning decisions that would eliminate poorer choices.
Although these were hypothetical scenarios and not real-world projects, it is clear that tax incentives for offshore wind help the embryonic U.S. offshore wind industry by allowing a higher percentage of the potential outcomes of a project to be positive.
Having a positive mean NPV for a project does not necessarily make it financially appealing. However, the shift toward higher returns and a greater percentage of positive outcomes allowed by tax incentives reduces the financial risk and allows more projects to move into a range where investors and financiers would be interested.
If PTCs and ITCs are authorized only for periods of time that are shorter than the time required to plan offshore wind projects, then the tax credits cannot be considered when assessing the financial viability of the projects. In order for tax credits to be useful to the offshore wind industry, they need to be extended through 2020 or beyond.
Both the ITC and PTC aid the financial viability of offshore wind projects by reducing the chance of negative returns, but the ITC provides a greater increase in positive NPV. In 99.7% of the results, the ITC allowed a higher project value. Simply put, the ITC is of greater value to the offshore wind industry. w
Industry At Large: Project Finance/Offshore Wind
Why The ITC Matters For Offshore Wind
By Constance McDaniel Wyman
Financial models reveal that for offshore wind development, the investment tax credit is more beneficial than the production tax credit.
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