Wednesday, March 13, 2013

Uncertainty, Wind Power, and How the U.S. Fumbled Its Policymaking

Alex Christensen is a graduate of Washington University in St. Louis. There, he was an economics and political science student who developed a keen interest in renewable energy, macroeconomics, and the role of institutions in public policy.  He has written for Americans for Energy Leadership and Minnesota 2020. Since graduating, he has worked for a Fortune 50 company and as a public servant. This fall, he will be pursuing graduate studies in economics at London School of Economics. If you're ever looking for a bassist in your band, Alex is also the guy for you.

For much of 2012, the wind power industry was in 'hurry-up-and-wait" mode. There was tremendous uncertainty over the future of the Production Tax Credit, which was set to expire on December 31, 2012. Not knowing the "rules of the game" for 2013 and beyond, wind investors and developers responded by curtailing their plans for growth in 2013. This is a classic example of institutional uncertainty on growing industries. For wind power in the United States, this is just the latest example of a longstanding detrimental institutional structure - and is responsible for the lag behind other developed nations in renewable energy adoption.

2012 was a banner year for wind power. 12,620 MW of wind capacity was deployed, making it the biggest year yet for the industry. At first glance, this seems to show that growth in the United States’ wind sector is accelerating and the policy framework is accommodating. But as is often the case in the social sciences, initial suspicions can be misleading. The surge in American wind power installations in 2012 is in fact a product of rather inept institutional structure, and because of that 2013 is predicted to be a lackluster year for the industry.

Two vital pieces of evidence point to the political disconnect that is generating uncertainty in the wind industry. First, the future of the Production Tax Credit for renewable energy remained in limbo for most of 2012 – only to be extended through 2013 in the January 2nd Fiscal Cliff deal. The months-long wait for the PTC extension caused an uncertainty-fueled panic among wind developers to complete any current projects in 2012 in order to receive the PTC – then hope that 2013 would be more promising.

The second point illustrates the mad dash to put wind turbines into operation before the end of the 2012. According to the U.S. Energy Information Administration, approximately 40% of the total capacity additions in 2012 occurred in December –the month the PTC was set to expire. No month of 2012 tallied more than 1.5 MW put outside of the over 5 MW in December.

So if the PTC was extended through the end of 2013, why is growth in wind expected to slow this year? Because planning, building, and getting a wind farm into operation takes quite a bit of time. Building and installing turbines does not happen instantaneously, but might seem like it compared to the time it takes to find financing and navigate the complex permitting process. I’ve spoken with wind developers in Minnesota who say it can easily take an entire year to receive approval attach new turbines to the the Midwest Independent Transmission System Operator (MISO) grid.

At the heart of the recent experience of the wind industry is a dramatic increase in uncertainty. In the sense that it faces uncertainty in general, wind is not unique. Agriculture can be hurt by unexpected droughts; retailers can be hurt by recessions cause by financial crises. Wind power developers have always experienced uncertainty in the same vein – they can run into fervent NIMBYism when planning projects and other energy sources can become relatively less expensive. But the kind of uncertainty that the wind industry experienced in 2012 is of a different nature: institutional uncertainty.

2013’s ‘Rules of the Game’ were in limbo for months, and were only codified on January 2nd, 2013. At a theoretical level, the actual impact of the PTC – a credit of $.022 per kWh – would likely be real but small. Its most likely effect would be to funnel wind developers’ installation efforts towards a concentrated number of highly profitable sites (those with lower installation costs and higher wind speeds).

By not extending (or explicitly ending) the PTC, the United States federal government magnified the effects of a potential $.022 decrease in per kWh revenue. Suddenly, it becomes more difficult for investors to evaluate the industry, especially in a risk-averse market (which many investors still are after the Recession of 2009). The range of expectations about returns on investment grows, and drives some investors out of the wind market. For those who are still willing to invest, the increased uncertainty leads to demand for higher interest rates in order to make expected returns positive.

Some industries maybe would have only been minimally impacted by uncertainty of this nature, but wind is not one of them. Investment is a vital component of the wind industry. Once a wind turbine is in the ground, it is almost free to produce power, but the costs to get it in there are steep. Wind farms can come with a price tag of $500 million, and unless developers can find funding they will not be able to start their endeavors. The up-front capital costs are recouped as the turbines spin and create a revenue stream, but all of the turbines must be purchased before then.

Having seen how the end of 2012 played out – a dramatic effort on the part of wind developers to put their turbines into operation while they knew they would still receive the PTC, leaving fewer than desirable projects in the pipeline – provides guidance on how public policy can inhibit the growth of new industries. It also gives policymakers a chance to design a program that does not create the same problems for the wind industry. Cementing the PTC as a permanent program would certainly do this, but it may be politically difficult. Another solution would be to set a date on the middle-term horizon (say, 8 or 10 years from now) by which the PTC would be eliminated. Between now and then, the PTC would gradually fall to zero. Under this plan, the institutional message to the wind industry would be that regulation and subsidies will be undertaken in a deliberate and predictable fashion.
The wind industry’s experience with the PTC is just one of numerous examples of policymaking creating uncertainty, but it serves as a tremendous illustration of how inaction on a relatively small piece of the institutional framework can interrupt an industry. In the case of wind power, which is generally considered a ‘good’ industry – and one that the United States already lags behind its developed peers in – uncertainty has led to layoffs in wind-heavy states like Iowa and Minnesota and poor prospects for 2013.


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