Mike Garland, ceo of Pattern Development and president and ceo of its yield company, Pattern Energy Group (PEGI), gives his view on trends in the availability and pricing of power purchase agreements, the competitiveness of offshore wind and the latest developments in the tax equity market in the first part of this exclusive interview with Richard Metcalf, editor of PFR.
PFR: Your business relies on your ability to obtain power purchase agreements or other offtake contracts for your projects. To begin with, could you tell me about how you view the availability and pricing of PPAs?
PPAs have always ebbed and flowed in the market in terms of how many there are. You’ve been paying attention to this market for a while, so you know that last year while there were less PPAs, what people would call PPAs with the utilities, there’s a substantial uptick in commercial contracts where major corporations and even medium corporations have contracted directly for renewable power, as opposed to having to go through the utility. And so you have to look at the whole breadth of contracting opportunities out there.
I think last year there was a bit of a lull in the U.S., because I think people were saying: ‘Jeez, the [production tax credit] has now been extended out essentially four years, so why rush to do a contract?’ And I think it slowed down the market. People were digesting what they had, they were seeing markets around the world, [requests for proposals] around the world, coming in highly competitive. So in the U.S., I think there was a slowing down by some offtakers because of that. They didn’t feel the urgency. We weren’t falling off the PTC cliff.
I think there will be continuing new opportunities for PPAs and contracts with both corporate as well as commercial financial parties. I think you’re going to start seeing, in the coming years, a big pick-up in North America around the [U.S. Environmental Protection Agency’s] Clean Power Plan and the accords that have been reached about trying to do more renewables and reduce carbon, and that’s going to start driving offtakers and replacement power, which will require power purchase agreements as well. So I think there are a number of opportunities out there, enough for this industry to stay strong.
They are getting more competitive. We’ve seen it in certain areas; we’ve seen it in Mexico and Chile and elsewhere, where people have become very aggressive. They’re not pricing in country risk or exchange rate risk or other things you might reasonably do as a financial investor. We think that’s too aggressive, and I think it’s a reflection that some markets have slowed down, which means people need to fill their backlog with opportunities, and you’re starting to hear some banks push back on some of these projects as being too aggressive in their pricing.
We don’t think they’re complete lunatics. They’re not completely crazy, some of them, we think it’s just that they’re a little more competitive than they probably should be. Their assumptions on, like I said, foreign exchange and other things.
I think we’re even seeing some parties look at debt costs, particularly Europeans where debt costs are very low, and so they do corporate financing of debt and they’re building in a very low cost of capital related to debt, and then being aggressive on some of these other fronts that end up being, overall, extremely aggressive.
I think that’s a characteristic that we’ve seen a rebalancing, if you will, or a change in balance. Clearly, the U.S. is one of the bigger markets, and when it slows down, other markets start becoming a little more aggressive, I believe, and I think we’ve seen that. I think as things start picking up again, as some of the supply chains fill up, I think you’ll see some of the pricing normalize again, and be more reflective of some of the efficiency improvements that are going on in the technology—solar and wind—rather than just a financial competitiveness.
I think the key here is: If you read almost all of the participants’ reports—the participants that are public anyway, and the ones that are private when they talk about it—the difference in cost of capital that people report is not that big. It doesn’t drive the competitiveness as much as assumptions do. Are you aggressive on your wind? Are you aggressive on… one of the biggest areas currently on competitiveness is how people are looking at the forward curves for the spot market when you come off of your PPA or when you’re on a hedge, where you have some spot market prices, and then you have your residual period after the PPA or the hedge—what is your assumption?
We tend to be more modest than most, in that when we look out forward, if we’re bidding a contract at $40/MWh, we don’t think it‘s rational to look out 15, 20, 25 years and assume the market’s going to be, in real terms, 50% or 100% higher than $40. We think that it’s more rational that the industry will continue making improvements, and cost improvements, and the real cost of energy will potentially even go down some, but at the very least it will be similar to what it is now, and not these curves that show this huge increase in energy costs 20 years from now.
PFR: Speaking of PPAs, we had the announcement of the initial results of the New England Clean Energy RFP [on Oct. 25] (PFR, 10/26) and one of the projects that was in there that didn’t progress to the next stage was King Pine, which of course Pattern was planning to acquire from SunEdison.
We did acquire it.
PFR: I thought that was conditional on the project getting a PPA?
No, we really didn’t have a strong view on whether we were going to get a PPA in this first round or not, because that was bid fairly early in the process and I don’t even think the phase-out of the PTC or the PTC extension was passed when the bids were submitted. I think there were some assumptions around some level of PTCs, but it wasn’t clear how many. So while we thought the price was pretty good and we were hopeful maybe it would work out, that wasn’t the reason why we bought the project.
We think that fundamentally it’s a unique project in the Northeast and has some very good competitive advantages that, in the medium and long-term, will prove to be a very good project. And so, while obviously we’re disappointed—we’d love to have been handed a 600 WM PPA—it was not really expected.
Particularly when you look at [the fact that] the decision by the tri-state was to award roughly 450 MW, and the project is 600 MW, you can’t really expect them to give 100% of their award to one party like us unless it’s just a super deal. And so there’s plenty of other demand out there, as you know, Massachusetts and others have directed for more renewable energy, and we think that King Pine is in a good place to take advantage of some of those upcoming opportunities.
PFR: We’re seeing a little bit more activity recently in offshore wind as well. Is that an area that you’re looking at getting involved in?
We have an offshore project in Japan—it’s sort of a wading pool, in that it’s only 30 meters deep, and so it’s not offshore like many of these projects that are quite deep—and so we’re not really looking to do offshore in North America or Europe right now.
We previously were involved with offshore on the eastern side of the U.S. and we sold that business off when we created Pattern, and the reason for that is that we think that’s a much longer-term play. And maybe over time as PEGI gets bigger, we can take on some of these offshore projects, as the technology and the competitiveness become better for the industry. But right now, if you look at offshore, it’s still quite expensive relative to onshore: It’s many times more cost per megawatt hour. So we are still reluctant to go into the offshore business, partly because of the risk and partly because of the competiveness of the pricing and the size of our balance sheet.
I think that there are some players out there starting to show that there’s opportunities that can happen. Northland [Northland Power], I think the initial indications are that they have done a good job on their [Gemini] project in the North Sea and that’s going to be helpful I think to the industry in gaining confidence. For years, all you heard about were cost overruns, and so an indication that projects are starting to be built on budget is a positive thing that could influence us on the risk side of offshore.
PFR: Once you have an offtake arrangement, looking at the North American market, how do you view the availability of debt and tax equity to finance projects?
It’s still good. The debt is strong. Tax equity, I think, will be freeing up. You’ll have some people getting out of the market, meaning that some of our competitors will be turning taxable and so they won’t be in the tax equity market as much, and so we’re hopeful that there will be plenty of tax equity. As I said, what’s happened is, there’s been a little bit of a spreading out, if you will, over the next four years, of construction of some projects. And so I think that will help the liquidity in the tax equity market as well. But we don’t see any limitations right now on tax equity or debt for our projects.
PFR: You talked about some of your competitors potentially turning taxable and therefore not requiring [third party] tax equity any more. On the other side of the equation, people were talking at the beginning of this year about possibly new tax equity investors coming into the market. Is that something that you’ve seen?
Yeah, we’re seeing a number of players. I think there are some improvements in the financial products associated with tax equity—that helps. And certainly the industry is interested in getting more liquidity. If there’s a way to improve the tax code to allow for more liquidity, we’d love to see that. In terms of new players, there are a number of new players coming in.
Some of them are smaller, but we’ve seen this historically in the past with large capital market demands for tax equity, where it takes several years for it to gel. If you remember, in 2009, there was no tax equity to speak of, and so we’ve taken several years to recover to where people have a confidence in their tax position again. We’re seeing some tax equity come in more easily on the solar side, because it’s a one-time, up-front, ITC structure, which allows them to know that their current tax position can use the tax benefits, whereas with the PTC you’ve got to have confidence that you’re going to be able to use it over 10 years.
So it takes a little longer to develop that tax equity market, but we’re starting to see it happen again. It happened in the past—tax equity markets where the regional banks would start playing more and so on, once they felt confident that their outlook for paying taxes would stabilize—and so I think we’re seeing right now a resurgence of people wanting to have renewables in their portfolio. It’s a positive because there’s such public support that a lot of companies want to tout that they are investing in clean technologies and helping move us to renewables in this country and others, and so you’re seeing more and more interest even in the tax markets for new companies to come in.
PFR: You mentioned improvements in the financial products associated with tax equity. Can you go into more detail on what you meant by that?
Yeah, for example for some investors pay-go structures are more comfortable than all-up-front funding. I mentioned the ITC for solar, for some companies, when they look at their current tax bill, they can manage an ITC transaction because it lowers their current tax bill and they don’t have to project out for 10 years. Those are the sorts of things that help expand the market.
Check back next week for the second part of this interview, in which Garland discusses the debt market in more detail and gives his view on yieldco equities and the prospects for future dropdowns.