Group 6, Week 4: Success with Subsidies - Wind Production Tax Credits
In our previous three blogs, our group has discussed the various options for renewable energy subsidies and argued that these subsidies are a worthwhile endeavour for the U.S. government to undertake. In this post I’m going to give an example of a successful renewable energy subsidy, production tax credits (PTCs) for electricity generated via wind, and hopefully convince you that similar programs have benefited, and will continue to benefit the U.S. moving forward.
What is a PTC?
PTCs were created as part of the Energy Policy Act (EPACT) of 1992. The PTC is a corporate tax credit for renewable energy sources, including wind, which credits 1.5 cents per kWh for electricity produced. The PTC has expired and then been renewed several times over the years through various pieces of legislation including the Job Creation and Worker Assistance Act of 2002, the American Jobs Creation Act of 2004, the Energy Policy Act of 2005, and the American Recovery and Reinvestment Act of 2009.
As it stands today after the most recent renewal, the PTC pays out 2.3 cents per kWh hour for electricity generated from wind during the first ten years of operation. The 2.3 cents per kWh hour is simply the original credit rate adjusted for inflation since 1992.
Why were PTCs Created?
PTCs were created to help spur economic growth through private investment, help improve energy security in the U.S., and help create affordable energy.
Creating wind energy is a capital intensive process that requires large amounts of spend to occur early in development. Over the last 25 years, the technology surrounding wind energy has drastically improved, but towards the beginning of that time period most wind projects did not make sense because of the high initial capital outlay. The PTC has incentivized the private sector in the U.S. to make investments in wind generation by providing them ten years of tax relief and thus made many wind projects economically viable for corporations.
Energy security is defined as the association between national security and access to various sources of energy for consumption. The idea here is that access to reasonably priced energy is key for modern economies and an uneven distribution of energy supplies has lead to various vulnerabilities. Increases in the supply of renewable energy from wind leads to increases in diversity of energy sources and increases in energy resistance to price shocks when the supply and demand for natural resources fluctuates. PTCs were designed to stimulate growth in the renewable sector thus making our energy economy more resilient when facing changes in macroeconomic factors.
Finally, growth in renewables protects U.S. families and business from price shocks in traditional energy sources like coal, natural gas, and oil. Once again, access to affordable energy is imperative for modern economies; small business and families need to be assured that energy prices remain at least reasonably stable so they can grow and contribute to the economy. PTCs were created to incentivize growth and diversify our domestic energy sources. Given that we haven’t built a new nuclear reactor since 1978, the U.S. needed a way to augment fossil fuels; PTCs have bridged that gap and now wind accounts for a significant portion of our domestic energy generation.
How have PTCs Helped Grow Wind Energy?
PTCs for wind have worked; by the end of 2015, the U.S. had an installed capacity of 72,472 MW of wind energy. Over the last 15 years, the growth of wind has exploded due to advancements in the technology and the PTC’s ability to make wind projects economically sensible for private investment. The following graph shows the growth in U.S. wind capacity since 2000:
You’re probably a little skeptical of my claim that the PTC has really engendered growth in wind energy capacity. The PTC has actually expired for somewhat long periods of time over the last 15 years, and when it has, the number of wind energy projects has significantly decreased during those periods. The PTC has been allowed to expire in 2000, 2002, 2004, and 2013. Predictably the number of new wind projects undertaken during those years was very small. The following graph shows the annual amount of wind power installed each year:
To summarize, we have seen the smallest amounts of wind power brought online in years where there was no tax incentive. We have also seen stable and consistent growth in long stretches when the PTC was extended or not close to its expiration. Yes, technological growth has certainly helped move wind energy in the right direction, but the PTC has provided the means for companies to get these wind projects off the ground. It is reasonable to conclude that as companies build more wind farms, the technology gets better through learning and continuous improvement processes, thus these projects will become more economically stable.
Estimated Benefits
The benefits that come from increasing our wind capacity are pretty obvious from an energy generation standpoint; we have access to more diverse energy generation methods, we are less reliant on foreign entities for energy, and we are more protected against market fluctuations in prices for traditional sources of energy.
But the PTC’s stimulation of wind energy growth has also given us other economic benefits. In early 2017, the American Wind Energy Association has reported that wind power now employs just over 100,000 Americans according to new data released by the U.S. Department of Energy. The DOE has also estimated that 380,000 American wind jobs could be created by 2030. The PTC has sparked energy growth with its ability to convince corporations to invest in wind-renewable projects, and through that growth, a new industry has been created providing jobs and economic prosperity.
In 2013, NEXTera Energy released some projections on the economic benefits of the PTC if it were to be extended for one year. They estimated that the net government benefit of the PTC would be $768M through additional federal, state, and local taxes collected during the construction and operation of new wind farms that are made economically viable through the use of the PTC. The idea here is pretty simple, the tax credit costs $3.5B over the first ten years as its paid out to the energy producers, but the government can collect more taxes over the 20-year lives of the new wind farms leading to an overall net benefit. The following chart summarizes their findings:
The PTC has done its job very well over the last 25 years; it has incentivized and captured private investment in wind and thus there has been continuous improvement in the capacity of wind energy. As wind energy continues to improve, the use of the PTC can be lessened as projects are more economically attractive as the technology gets better. With the lessening of the PTC, the U.S. will be able to capture the tax revenues that come with constructing and operating wind farms but the cost of PTC will begin to decrease, which increases the overall net benefit.
Future of PTCs
In 2015, PTCs for wind energy were extended through 2019, but a “phase-down” would begin in 2017. The phase-down will knock 20% off the 2.3 cents per kWh rate each year; so projects started in 2017 get 80% of the credit, projects started in 2018 get 60% of the credit, projects starting in 2019 get 40% of the credit, and projects after 2019 will not receive the credit.
This seems like a reasonable way to end the PTC for wind energy, as the final five year extension provides stability to the industry and allows room for predictable growth even as the credit abates. Since the PTC’s inception in 1992, wind energy has seen enough technological growth where the projects are making economic sense even without the PTC. The American Wind Energy Association estimates that by the end of the PTC, wind energy will account for 10% of domestic energy production.
Conclusion
The PTC for wind was effective on a number of fronts. The most general goals of the wind PTC were to incentivize private investment and to diversify our energy portfolio. These goals have clearly been accomplished; during times of stability for the PTC, growth was consistent and constant as opposed to uncertain times for the PTC when there was almost no growth. This clearly shows that the PTC funneled corporate dollars into renewable-wind projects. As wind technology has improved, corporations will likely continue to invest in these projects when the PTC goes away after 2019 because the technology has matured to an economically sensible point. After 25 years of the wind PTC, wind now accounts for about 10% of our domestic energy production, meaning that the PTC also helped us add diversity to our energy sources. From an economics standpoint, the PTC has created a new industry with 100,000-plus jobs and there has been a calculated net-tax benefit for the U.S. government
Subsidies make sense for nascent renewable energy technologies. Early stage renewable energy technologies require capital investment to grow, but this investment is scant when these are not positive NPV projects. PTCs and other energy subsidies incentivize corporations to fund early stage energy projects and it gives the energy companies themselves a way to learn, grow, and make these projects profitable in the future. PTCs have the potential to continue driving innovation and investment in the energy sector as the world continues to demand viable forms of renewables.
Scott- This is one of the best written blogs I has read this Mini. Hard to argue any of the points discussed especially when framed as reducing reliance on other natural resources AND showing the net benefit to the government is a positive.
ReplyDeleteAs this is a finance class, what might help strengthen this case is knowing the “expected return” the government would receive… meaning at what return rate is the positive NPV calculated with. If 2% I think is hard to say it is a net positive, though you could argue if we invest in renewable energy, so long as we break-even (or perhaps even a slight loss), the government should continue the PTC’s.
Again, great job.
Scott,
ReplyDeleteThe argument that government can realize a net benefit of +768M is the way lawmakers should be thinking about spending tax dollars on energy programs. The producers receive a short-term tax break to lessen upfront investment, and the government receives the benefit of a long-term tax revenue stream. This allows government to take a cut of the operating margin of the energy producer, instead of hamstringing the initial construction budget.
Aaron raises a good point, however. Does the tax revenue received after the 10-year tax reduction period impact the NPV of the project? To a degree, government may not care all that much; you did present graphics that show energy producers react strongly to the expiration of the PTC. Assuming these producers are acting optimally, the NPV must be positive. Otherwise, why the spike and trough of wind farm investments?
My last point/question is what is your position regarding the 2017 “phase-down” of the PTC? Is the phase-down justified because wind farms have reached a critical mass in number to reliably supply the U.S. with a hedge to price volatility in fossil fuel markets? Or have the wind farm lobbyists simply had their fill at the table? It seems like it would make sense to continue the PTC’s without a phase-down, but the concept of a phase-down is not illogical to me, because there might be a better tax credit level to balance the tax break given with keeping the wind farm projects still at a positive NPV. … Also, has the technology for wind energy production improved such that a lesser PTC rate is justified?
A well written piece explaining the economic benefits and impacts of the PTC! I agree that the PTC extension gives solar and wind time needed to ensure that production from renewables is the cheapest option to produce power by 2020. Taking a brief glance at the latest LCOE (levelized cost of energy) for natural gas vs wind power from the EIA, we see that
ReplyDeleteConventional Combined Cycle is 58.6 [$/MWh]
Advanced Combined Cycle is 53.8 [$/MWh]
Wind (onshore) is 55.8 before the PTC and 44.3 [$/MWh] after.
(Source: https://www.eia.gov/outlooks/aeo/pdf/electricity_generation.pdf)
This puts wind right there in the middle even before the PTC. This is definitely promising and hints that renewables (or at least wind) is set to under cut natural gas before long. (Note: in your blog you said kWh hour but a kWh already denotes kilowatt-hour, just fyi).
I didn't know how drastic the decrease in installations were in years without the PTC so that was definitely a point driven home. Analysis by Bloomberg New Energy Finance also shows that the PTC extension until 2020 will lead to an increase of 19 GW of windpower (ontop of the expected cumulative build of 25 GW) for years 2016 to 2021. I also agree that because of the gradual fade out, investors and industry can plan accordingly to avoid 'boom-and-bust' cycles of wind installation.
If anyone were to have gripes about the PTC, it would be that it does not distinguish regionally between states' existing renewable portfolios. So the PTC gives out the same amount for states/regions that already have a pretty high penetration of wind versus those that don't which is good in that its not discriminatory but it doesn't do much to spur growth in states or regions that don't have as much renewables currently. Although there is justifiably locational limits due to renewable resource density, it may be a point that the PTC could do better while others might say that that would make things unnecessarily complicated.
References:
https://data.bloomberglp.com/bnef/sites/4/2015/12/2015-12-16-BNEF-US-solar-and-wind-tax-credit-impact-analysis.pdf
http://www.energycentral.com/c/um/geographic-disparity-ptc-itc
Hi Scott, thank you for writing such a well researched post!
ReplyDeleteI agree that wind power is very close to being competitive with traditional energy sources. Over the last 20 years, the cost of generating electricity from large scale wind systems has dropped more than 80%. If we see fossil fuel energy prices spike again sometime soon, we could expect that the average wind energy development to be economic even without the PTC subsidy.
That said, I wanted to highlight what will likely be a major hurdle for wind energy going forward. Transmission costs are a major issue in wind energy development.
A number of the prime wind generation locations are in areas far away from the consuming population centers. This poses a big issue - there will need to be infrastructure investment made into transmission lines and grids to support the wind generation being done in these remote areas. For instance, there is a great deal of potential wind development that could be done in North Dakota. Unfortunately, North Dakota does not have the thriving metropolitan areas of say Texas or California that can benefit from wind generation investment. Viable wind generation in North Dakota is infeasible at this point just given the lack of infrastructure there to support wind.
Another prime location for wind generation is the Aleutian Island chain in Alaska, which have some of the strongest and stiffest wind on the planet. These remote islands necessitate advanced forms of energy storage and transfer that are simply not the norm. A massive upgrade of the transmission lines nationwide would be needed to tap some of these more distant and remote locales.
While I support the PTC and what it has done to help wind producers reach a level of competitive pricing, I think energy policy needs to begin to shift to meet our future needs. It would be great to see Congress address our outdated transmission grids so that we could perhaps open up new geographies - like North Dakota and the Aleutian Islands - to wind generation.
Nice post. It’s really hard to make a quantitative argument demonstrating the net benefits of wind or any energy source. The electric grid is complicated and it is intertwined with a lot of less tangible social issues. Probably, the greatest effort to consider everything together can be found in the large number of “Value of Solar” studies produced by many states. These studies consider grid costs and benefits (e.g. reduced losses), environmental benefits, job creation and a lot of other categories. On one hand, it would be great if we had similar studies performed for wind energy. On the other hand, there are number of pitfalls in these types of studies.
ReplyDeleteI agree with David that the interconnection costs are one important consideration. Other potential grid costs associated with wind include its ability to provide dependable baseload power, its ability to provide dependable peak capacity, and the increase in cycling it creates for other power plants. It also doesn’t play well current power plant economics because it “cannibalizes” (i.e. decreases) locational marginal prices. Probably, Texas is the most interesting state to watch here since it has a lot of wind, doesn’t have a capacity market to compensate for wind’s low marginal price, and has experienced several wind droughts. If these costs and benefits of wind can be quantified anywhere, it might be in Texas.
I agree with Peter and Aaron that it is difficult to argue definitively that wind provides net tax benefits unless you consider the NPV. This argument might seem abstract at first, but the discount rate really describes the ability of the government to earn revenue from other power plants that might require fewer incentives. Unfortunately, this analysis becomes difficult because fossil fuel plants and nuclear power have all received significant government investments throughout their life. So, while it might be ideal to consider the NPV, it’s definitely not a trivial exercise.
The possibility of job creation, increased energy security, gaining global leadership in innovation further complicate the analysis. I think this kind of post provides a baseline with which to view renewable energy incentives. We probably won’t know the true value of wind and other renewables until they’re built.
This is a really good and comprehensive post that considers not only the past but the future of wind power. Well done! It did get me thinking in general about renewables and at what point we stop giving long term incentives like the PTC which was initially set for 10 years, ane perhaps focus on setting incentives that are more flexible in order to be easily be modified in reflection of market conditions. In as much as these incentives are good to increase renewable share, a conscientious effort should also follow in an attempt to keep modifying them so that the power sector stays competitive and robust whilst still achieving all its goals of providing efficient power as well keeping environmental concerns in mind. Additionally I found the idea that PTCs had direct impacts on how much wind was deployed very interesting and would like to see if there is some more concrete evidence to support this fact apart from what is stated here, to make the argument just a little bit stronger. Again great job!
ReplyDeleteVery nice overview of the PTC. Clear point: “this policy has worked, we’d be worse off without it, and we are now ready to transition away from it.” I will take issue with a few of your conclusions (and what they are based on), but, overall, this is exactly the sort of thing that I’m looking for.
ReplyDeleteYour discussion of “why PTCs” ends up being just as much “why subsidize wind.” This is fine, and you make some good points. But what’s worth thinking a bit more about is “why PTC versus other types of subsidy?”
I take some issue with your assertion that the variability in development that coincides with the PTC being revoked/renewed demonstrates that the PTC has “worked.” One would expect developers to delay given the expectation of the PTC to be renewed. This would make sense even if the wind projects were economical on their own, without subsidies. My sense is that an expectation of renewal was indeed a reasonable one during the years in which it went away.
I’m even more skeptical of the argument that the PTC pays for itself. This presumes that there is no alternative activity (eg, gas-fired generators) that would have resulted in tax revenue, in lieu of PTC/wind development. I don’t believe this. There are lots of good reasons to subsidize renewables. But the subsidies themselves being an NPV>0 cash-flow project is hard to believe.
Suggestions for another question? Why subsidize through the tax system at all? Doing so has generated some possible negative side effects, mostly due to the fact that renewables are making money and that things like tax equity investors have been called in. Negative side effects? Maybe just the transactions costs associated with the complex tax equity, project finance companies? Also, one might compare the PTC with the ITC.
Nice work
Grading Rubric (badly formatted because comments don’t allow formatting)
Possible “grades:” Excellent (E), Very Good (VG), Good (G), Could be Better(CBB)
Takes a clear position: VG
Substantiates the position: G
Informs the casual reader: VG