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Soaring Demand, Other Factors Drive Wind Turbine Prices Higher

Thanks in large part to the extension of a key federal production tax credit (PTC) by the U.S. Congress through 2007, the U.S. wind power sector is experiencing phenomenal growth, with thousands of megawatts of the renewable resource being added to the country's power grid.

Less noticed has been a rise in turbine prices influenced not only by soaring demand, but also a number of other factors, including limited manufacturing capacity. While the good times roll in the wind sector, increased wind turbine prices have thrown a monkey wrench into at least a few wind power projects or related contracts.

In 2005, lawmakers on Capitol Hill extended the PTC through the end of next year, offering a measure of short-term stability to the wind power marketplace. That stability in turn has spurred a number of wind power projects across the U.S.

In late January, the American Wind Energy Association (AWEA) reported that the U.S. wind energy industry easily broke earlier annual installed capacity records in 2005, installing nearly 2,500 MW, or more than $3 billion worth of new generating equipment, in 22 states. The trade association reported that 2006 is expected to be even bigger, with installations topping 3,000 MW.

But a spike in turbine prices has created problems for some players in the wind power arena. Last year, a long-term contract that called for Xcel Energy to get 69 MW of wind-generated power was canceled. Xcel would have procured the wind power from a group of five landowners in southeastern Colorado who have permits to develop a wind project on their property.

At the time, spokespeople for Xcel and the project's developers said talks broke down over the ultimate price that Xcel would have had to pay to support higher than previously expected turbine costs for the project.

More recently, Xcel on Jan. 23, 2006 submitted a filing to Minnesota utility regulators seeking an order approving an amended and restated power purchase agreement (PPA) with MinnDakota Wind LLC for approximately 150 MW of generation. MinnDakota is a single-purpose entity created and owned by PPM Energy.

The wind project was one of the June 2003 selections identified in Xcel Energy's final evaluation report for a 2001 all-source competitive bidding process. In October 2004, the Minnesota Public Utilities Commission approved a PPA for the project.

"Because of the federal government's method of short extensions of the federal production tax credit (PTC), and various commodity market pressures (such as steel and concrete), the turbine and wind project construction market has experienced significant price increases over the past year," the filing noted. "As a result, the prices bid in 2001-02, and contracted in December 2003, needed adjustment in order for this project to be able to move forward."

Meanwhile, higher turbine prices played a role late last year in the suspension of plans to build a wind farm in North Dakota. The project involved Otter Tail Power Co. and two other energy companies -- FPL Energy, a leading U.S. wind power developer based in Florida, and Calgary's Enbridge.

Pricing of turbines was "one of the two key factors" involved in the project's not going forward, Otter Tail Power spokesperson Cris Kling told NGI. As proposed, the project would have had a capacity of approximately 70 MW.

"We had regulatory filings in three states and the way things were going, we just thought it was best to pull those regulatory filings because so much had changed since we filed them. We had originally filed in late April 2005," Kling said, noting that the project "is not going forward at this time." She said that "we'll look at it again, but I think at best, we'd be maybe looking at 2007 before we'd be prepared with anything again."

Kling noted "we had issues getting approval of the business structure that we were proposing for that project and it was admittedly a complex structure, and I think that was part of the concern."

The second factor causing the southeastern North Dakota project to be pushed to the sidelines involved a rise in the price of turbines "since we had filed. Because the production tax credit had been extended, other projects around the nation were going ahead and that meant that turbines were not as available going into 2006 and 2007."

Kling said the "law of supply and demand would tell you if there's more demand, there's going to be less supply and that's probably going to drive the costs up." She thinks manufacturers "were looking for more margin, knowing that that was probably going to be available to them."

It's difficult to nail down specifics when it comes to the going rate for wind turbines. Godfrey Chua, research director with Cambridge, MA-based Emerging Energy Research (EER), noted that key information related to turbine pricing is proprietary. "Any time a developer receives a bid proposal from the turbine supplier, they're actually asked to sign a nondisclosure agreement," Chua told NGI in an interview. "So these types of prices are held in high, high secrecy."

EER last month released details of a new study reporting that while the U.S. and Canada experienced record installations of wind power plant in 2005, an even bigger boost is expected in 2006 when new installations in North America will grow by over 50%.

In a press release announcing findings of its study, "U.S./Canada Wind Power Markets and Strategies 2005-2010," EER notes that despite record installations in the U.S. in 2005 and expected huge growth in 2006, the nearly $4 billion market has been constrained by turbine and component supplies. While the growth is unprecedented, wind turbine shortages have forced many wind independent power producers (IPPs) and developers to table projects. Others have taken advantage, EER noted.

"Some wind IPPs have discovered that by taking the financial risk and locking in turbine supply early, even before projects in their own pipelines may be ready, they can leverage these turbines to participate in late stage projects from other developers," Chua said in the release.

For wind turbine suppliers, control of the supply chain is becoming especially critical, according to the EER study. Turbine shortages result from pinch points in the supply chain, including gearboxes, castings and blades. Close relationships with key suppliers in these areas are important for ensuring that a wind turbine vendor is able to maximize production, EER noted.

The current wind power landscape has been influenced by two PTC extensions. The first is a late 2004 extension through the end of 2005, while the second is the more recent extension through the end of 2007.

Chua told NGI that "2004 was an awful year for the industry" with turbines collecting dust and sales practically nonexistent. "As soon as the first PTC was signed, with so many turbines...stockpiled, there was this big, mad rush to buy up these turbines" because they were still being sold at previous prices. "Pretty much even before January of 2005, every vendor's turbines that could be delivered in 2005 were sold," he said.

Several "external realities" faced turbine vendors as planning for 2006 and 2007 got under way, Chua noted. "Steel prices have skyrocketed in the last year. As you know, fuel costs have skyrocketed, too, and it's not an easy task to ship these turbines across the U.S. or across the ocean." Manpower costs and infrastructure support costs also come into play. "With the boom that the U.S. is experiencing, a lot of these costs were just increasing, and then you take China, which is buying up all the steel in the world, the cost of the steel to just make these wind turbines also started to increase," he said.

"As soon as people started planning for 2006 and 2007," vendors began introducing price increases, Chua noted. Some of those increases were as much as 30%, "which really caught some people a bit offguard. It's one thing to raise it 10% a year. But to just raise it 30% one year -- that's why it was a bit of a shock to the system."

The EER executive was asked to comment on whether turbine prices have leveled off recently or remain on the high end. Chua said that in terms of "pricing pressure, in terms of signing contracts, as far as we understand, obviously 2006 prices were raised by as much 30% and those prices hold through sort of 2007 and perhaps 2008," he said.

Chua said that as soon as the PTC was extended in summer 2005 "a lot of people were left out of the 2005 market because they didn't have wind turbines." When the PTC was extended, "a lot of developers learned their lesson and said, 'We can't let ourselves be left out of the market. Let's start signing contracts, not just for 2006 and the projects that are almost ready for construction, but also for 2007.'"

He noted that the wind power landscape has been altered by the entry of major players like Goldman Sachs and AES Corp. Companies such as these bring the "financial muscle to take on that kind of a risk."

Goldman Sachs Group in early 2005 agreed to acquire Zilkha Renewable Energy (now known as Horizon Wind Energy LLC). Chua said that "if you were one of those old wind power developers" just prior to this century, "you don't really have the money to go to GE and say, 'Hey, give me a hundred of those turbines for two years down the road and here's the deposit.'" In contrast, a firm like Goldman Sachs has "the money to do that," as well as the "breadth to take that type of financial risk."

AES entered the U.S. wind market in late 2004 by making an equity investment in US Wind Force LLC, a private company that focuses on developing wind energy projects in the eastern U.S.

Simple supply and demand is just one of several factors influencing the end-price for wind turbines. Along with steel prices, "it's just the limited manufacturing capacity," Chua said. "Ultimately, it's about global capacity."

A layman might wonder why a European manufacturing facility with excess supply wouldn't be able to ship its turbines to the U.S. to help alleviate shortages. But European turbines "are different from American turbines because their electricity systems are different," Chua noted.

"It's not an overnight switch and it actually requires anywhere from six months to as much as 12 months of pre-planing if you actually wanted to switch that capacity over." The process involves not just the wind turbine manufacturer itself, but also entails "what your sub-component suppliers produce. So they also have to do a switchover, so it's actually a rather complicated process."

Chua noted the seeming disconnect between the fact that the U.S. was "the largest market in the world" in 2005 when it comes to wind power, but has such limited turbine manufacturing capacity. "The reason for that is the production tax credit, which historically has created this boom and bust cycle for the U.S. wind market industry," he said.

The boom-and-bust cycle created a disincentive for wind turbine manufacturers -- and, in particular, European firms -- to set up shop in the U.S. "For them, it was just much easier to sort of diffuse this boom and bust cycle to hedge on keeping their manufacturing facilities in Europe and just dealing with this planning shift every year of how much capacity we're going to allocate to the U.S. or how much are we not," the EER executive said.

Last summer's PTC extension to the end of next year marked the first time that the tax credit was extended before it expired, Chua noted. "For the first time -- 2005 is a boom year -- but the PTC's still in place, so we're going to have consistent growth from 2005, 2006 and 2007." This three-year "window of growth is sort of the first step in enabling a greater sense of confidence in the industry looking forward to the medium term and the long term that perhaps a more stable path is ahead for the industry."

While GE Energy remains the dominant player in the U.S. wind turbine manufacturing market, the breaking of the boom and bust cycle in tandem with the explosive growth seen in the wind sector has prompted several turbine manufacturers to set up manufacturing facilities in the U.S.

"So far, three companies have made that leap," Chua said. The first firm was Spain-based Gamesa, which has set up operations in Pennsylvania. In September 2004, Gamesa agreed to base its U.S. headquarters and East Coast development offices in Pennsylvania. Plans were also unveiled at that time for Gamesa to open an advanced technology manufacturing facility for wind turbine generator blades in the state. "Their plant is actually supposed to be up and running by the first quarter of this year," Chua noted.

The remaining two turbine firms are India-based Suzlon Energy, which is setting up a manufacturing facility in Minnesota, and California-based Clipper Windpower, which has opened a facility in Iowa.

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