Wind comments from Q1 FPL CC:
Before we turn to your questions, we would like to spend a little extra time on the wind business. Recent developments in the external environment have focused increased attention on this part of our portfolio, and have highlighted its contribution to shareholder value.
At the same time, some observers have questioned whether our existing business model is the right one for the future. Both market and political developments over the last several months have been favorable for renewables, energy businesses generally, and it appears that more observers are coming to share the view that we have held for many years that wind has a bright future and can add significant value as one part of the energy mix of the future.
At the same time, however, the increased focus on renewables has led to some degree of confusion, and clearly there exists today a wide range of views both about what the market leading wind portfolio is worth, and about what implications current valuations might have for FPL Group.
To try and help investors make sensible judgments, we realize we need to do a better job of explaining certain aspects of the wind business. Today, we would like to briefly address four topics. First, the major drivers of wind project economics; second, the profile of expected PTC generation over time; third the contribution that wind makes to overall FPL Energy results; and fourth, our view of what I will call structural options, such as separating the wind business from the rest of FPL Energy.
Let me start by reminding everyone of the major elements of wind economics. While every project is different and some will have values outside the range as shown on this chart, the figures shown on chart 16, are typical for today's competitive climate. Capital costs today are typical in the range of 16.50 to 18.50 per kilowatt, depending upon location, terrain, equipment type and other factors. This is up substantially from a few years ago, that has generally been reflected in higher pricing. For tax purposes, wind projects that are available for five years may cause depreciation, and the typical project will be in the range of 50 to 150 megawatts, although as you may know, our largest is over 700.
Average capacity factor is a critical element for wind economics and the range is wide, but most of our recent projects and expected capacity factors are 35% or more. A project in the low 40s is excellent. Healthier free capacity factor is a function of geography and the particular local wind resource, and we devote a great deal of effort to modeling and estimating wind resource availability. Wind, of course, has no fuel cost and O&M is relatively small. Most projects' production costs are somewhere in the range of $4 per megawatt hour.
Depending upon competitive factors as well as the projects inherent to economics, mostly driven by capacity factor, contracted pricing will typically be somewhere between $30 and $40 per megawatt hour. Since competition is strong, a project with a high capacity factor will typically have a lower price and vice versa, or other factors equal. Finally, all projects that go into operation prior to the end of 2008 are presently eligible for production tax credits, which today are equivalent to $20 per megawatt hour, escalating with general inflation and which apply to the first 10 years of the project's life.
Combination of all these elements, generally yield projects with prospective cash-on-cash internal rates of return of 10% or better, with 10% to 12% being typical.
One key aspect of the wind business, which appears to cause some confusion, is the role what the production tax credits play in wind economics. To repeat, each new project qualifies for 10 years of PTCs, assuming it goes into service during a qualifying time period. Currently, new projects will qualify as long as they go into service prior to the end of 2008. As most of you know, PTC program has been extended on a number of occasions.
We view the PTCs as an integral part of project economics. In the typical contracted project, the value of the PTCs is effectively passed through to the customer, since we are able to bid at a lower price than would be the case in the absence of PTCs, while still earning an acceptable return. The PTCs apply only in the first 10 years of operation since virtually all our PPAs are at a fixed price or fixed with escalation. One consequence, is that the effective duration of the cash flows of wind projects are much shorter than that of a combined-cycle plant. We view this as a favorable characteristic, since it effectively means we are recycling capital and delivering an attractive return to the shareholder relatively quickly. This too is an integral part of the overall business economics.
We have observed two main approaches in external valuations of the wind business. One applies a multiple to a forecast earnings or cash flow stream, including the effects of PTCs. The other excludes the PTCs from the multiple valuation and values them separately, typically by direct discounted cash flow methods. We believe either can work effectively, but obviously only if the right input data are used.
To assist modeling efforts, we have developed chart 17, shown here, which indicates our current expectations of the future profile of PTC generation, expressed as megawatt hours eligible for PTCs under three different scenarios. The lowest curve assumes that we complete about 1500 new megawatts in the 2007 and 2008 programs and then add nothing more. The intermediate curve assumes this space to pass a subsequent annual program of 500 megawatts, with all additional megawatts assumed to qualify for PTCs. The upper curve assumes 750 megawatts per year from 2009 onwards, all qualifying.
As we said on many occasions, we believe growth of 500 to 750 megawatts per year, assuming continued public policy support is a realistic and perhaps even conservative goal for our wind development capability.
Please note that these curves show only the expected megawatt hours eligible for PTCs in each year. The total expected megawatt hours will naturally be higher.
From a valuation perspective, we believe that any approach that simply takes the discounted cash flow value of the lowest curve on the previous chart will result in values that are unrealistically low. Such an approach would miss a significant portion of the growth potential of the business.
While it is certainly true that there is no guarantee that the PTC program will continue indefinitely, the fact that the value of the PTCs is embedded in our project economics suggest that if the PTC program were to be eliminated at some future date, the principal impact would be to cause a rise in the price of wind energy relative to alternatives, else being held equal. As long as there is continued policy support for renewables, (i.e. through renewable portfolio standards) we see little prospect of this changing. There will still be a very attractive market for our wind business.
In addition, if market prices in the future come to reflect the direct price for carbon, which appears increasingly likely, wind and other non-emitting technologies stand to gain. In fact, one can think of the current PTC program as being an indirect way of building the value of zero-carbon emissions in to the economics of the business.
To apply a multiple based approach to the wind business, obviously requires a good starting point, in terms of income or cash flow contribution. As you know, we run the wind business as an integral part of FPL Energy's operations, and therefore to estimate an EBITDA or a net income contribution requires making some assumptions, primarily around the appropriate allocation of G&A expenses to different parts of the portfolio. Since many evaluations and analyses today are being done on the basis of projected 2008 values, in this chart, we have provided an estimate of the expected contribution of the wind portfolio in 2008 in a couple of different ways.
First, the straight forward expected contribution taking into account reasonable estimates of when actual projects might come into service, and second, on a hypothetical basis, assuming that all the megawatts of the 2008 program were in service for the full year 2008. This can be thought of as reflecting the annualized impact of the 2008 program, but expressed in 2008 dollars.
As you can see, the difference is significant since the full effect of any years build program does not flow through income until the following year. I should emphasize that the numbers shown in this chart are both forward-looking and employee non-GAAP concepts. However, they are prepared on the basis consistent with our regular earnings expectations calculations.
As you can see, the wind business is a very significant component of FPL Energy, even ignoring the PTCs, which as I said earlier, is an integral part of the economics of the business. We expect the wind business to account close to 30% of FPL Energy's EBITDA in this period. In fact when the PTCs are on a grossed up basis, the proportion is over 40%. At the same time, the rest of the portfolio is also a significant contributor to FPL Group's overall economic position.
Finally, a number of analysts and investors have asked about possible plans to separate the wind business completely or in part from the rest of FPL Energy, or alternatively to separate FPL Energy from the rest of the enterprise. The intent would be to highlight the separate economics and hopefully capture a higher multiple and is implicit in today's FPL Group valuation. We have been examining a range of options along these lines for some time; these include partial or complete spin-offs or IPOs as well as the possibility of attracting stock. Our conclusion to-date has been that each of these options have significant drawbacks, and it maybe helpful to explain our reasoning.
In thinking about these structural options, it is important to know that there are real operational linkages between the wind business and the rest of the FPL Group portfolio. In particular, operationally, we manage the entire non-nuclear generation fleet as a whole, and there are real synergies that we derive from this that benefit all the assets both in terms of cost and in terms of reliability.
Commercially, our relationships with key suppliers are strengthened by the breadth of activities in which we engage. Thus each of the structural alternatives, we have looked at has had associated with it some degree of real value degradation varying in extent generally in line with how complete any separation of the wind business might be. In addition, any structural alternative carries with it additional administrative costs and generally introduces challenging, but not insurmountable issues associated with dual fiduciary relationships. And of course the larger enterprise can utilize the production tax credits more efficiently.
For all these reasons our conclusion to-date has been that our current structure is preferable to the alternatives. This could change when external circumstances change, and we are certainly open to input on that subject. However, we do recognize that investors' ability to value the enterprise appropriately is in part a function of the information we provide, and therefore we have concluded that it will be useful to provide additional data on the wind business.
We hope that what we have shared today will make it easier for you to compare our wind business with other relevant benchmarks. To summarize the 2007 first quarter on an adjusted basis, FPL contributed $0.32, FPL Energy contributed $0.43, and corporate and other was a negative $0.05 contribution, as it is a total of $0.70 compared to $0.59 in the 2006 first quarter on an adjusted basis. To conclude, therefore, we are pleased with the start of 2007. We look forward to continuing to deliver very strong results for our shareholders this year and beyond. |
