Building a bridge to zero — questions swirl around design of wind incentive phaseout

Source: Nick Juliano, E&E reporter • Posted: Tuesday, June 12, 2012

Most renewable energy supporters agree that the boom-and-bust cycle created by reliance on temporary tax breaks and eleventh-hour extensions has not been an ideal arrangement, although lawmakers have been unable to agree on steadier forms of support.

The wind industry is the latest to face a potential bust if its prized tax incentive disappears as scheduled at the end of this year. While congressional aides predict the incentive will win a last-minute reprieve, attention in some policymaking circles has turned to an alternative arrangement with the potential to give the industry the certainty it desires while appeasing deficit hawks and skeptics of government backing for certain energy sources: a phaseout of the credit over a set period of years.

It remains an open question whether such a phaseout can gain traction this year. Most industry backers on and off Capitol Hill maintain a laser-like focus on winning an immediate extension to the production tax credit (PTC) for at least another year, noting that a sudden drop-off at the end of this year would cause tens of thousands of jobs to be lost while depriving the industry of billions of dollars in private investment.

But the idea is gaining favor with House Republicans — who would have to sign off on any PTC extension — and is seen as a real possibility for the wind industry. Executives and analysts predict electricity from turbines could compete with other sources of generation, without relying on subsidies, in as little as four to six years.

“Being able to compete on a more even playing field without incentives at the federal level is an area we’re not far from. That’s kind of the message we’ve been giving Washington to say, ‘We understand the fiscal situation of the U.S. and we want to be part of the solution,'” said John Graham, the president of BP Wind Energy, in a recent interview with E&E Daily.

“Don’t throw the baby out with the bath water now, because you’ll almost kill the industry right now,” Graham added. “We need a number of years’ help. [It is] very hard to predict is that two, four or six, but it’s kind of in that ballpark. It’s not forever, it’s not 10, and it just keeps us going to a place where we can compete on a more even playing field.”

The PTC was first instituted in 1992 and was most recently extended as part of the 2009 economic stimulus law. It provides wind energy developers 2.2 cents for every kilowatt-hour of electricity they produce; similar credits apply to virtually all renewable energy sources, but only for wind is the credit set to expire at the end of this year.

The credit has lapsed several times, followed by sharp drops in activity within the industry — a scenario wind energy backers say would be even worse this year because of the growth of domestic companies manufacturing wind turbine components. While the credit has broad bipartisan support in both the House and Senate, it has attracted increased criticism this year from some conservative groups that say it is akin to spending through the tax code.

Several Capitol Hill aides, speaking on condition of anonymity, predict the credit will be extended, but not until a post-election lame-duck session during which it could become part of a deal on extending Bush-era tax cuts or resolving other outstanding issues.

Deciding to phase out the credit — a conversation that could take place in the context of broader tax reform next year — is seen as one way out of the perpetual uncertainty within the industry caused by the credit’s periodic expiration.

“We’ve gotten into the mode with this … of just trying to keep it alive year to year,” said Judi Greenwald, vice president for technology and innovation at the Center for Climate and Energy Solutions, an environmental think tank. “And probably not enough serious thinking has been done about how you would phase it out over time.”

Gaining traction

There is clearly a growing appetite for phasing out the PTC, especially among some Republicans who are among their party’s top boosters of the industry.

Kansas Gov. Sam Brownback (R) last week called for a four-year phaseout of the credit during an appearance at the American Wind Energy Association’s annual conference, and supporters in Congress, including Rep. Steve King (R-Iowa) and Sen. John Thune (R-S.D.), have called for a phaseout.

Rep. Pat Tiberi (R-Ohio), who chairs the House Ways and Means subcommittee tasked with dealing with the PTC and more than 100 other “extenders” that expire at the end of this year, has said the wind credit is a top candidate to win an extension, but he has said he wants to see more information from the industry on how quickly it could be phased out (E&ENews PM, June 8).

Embracing a phaseout could aid the industry’s need for quicker action on renewing the tax credit, said Mark Murro, a senior fellow at the Brookings Institution who co-authored a recent study on overhauling renewable energy subsidies.

“This is where, politically, accepting the necessity of down ramps could help close the deal,” Murro said in an interview this week. “From a public policy perspective, continuity and predictability is crucial, so it’d be far better to attach extension to down-ramp in a single multi-year rule.”

But while industry trade groups are open to a phaseout, they say a discussion about those details should wait until after Congress extends the current expiration date beyond the end of this year. The American Wind Energy Association has said 37,000 jobs will be lost this year without an immediate PTC extension and that many of those jobs already are disappearing at manufacturing facilities as turbine orders dry up.

“We’re willing to discuss options for the future. You can’t turn a ship this big in an instant though,” AWEA said in a statement yesterday. “This is most likely a subject for the next Congress, when they look at tax reform and possibly more energy legislation. Meanwhile we are working hard to get a full one-year PTC extension as soon as possible, to avoid layoffs and keep this American industry growing. Let us finish the job.”

The sponsors of a Senate bill that would give the PTC an immediate two-year lifeline took a similar tack this week.

“The on-again, off-again tax policy, especially this year, holds back wind energy’s full potential. The stakes are significant. … My focus now is to ensure the continued success of this industry, and any changes to the existing tax policy should be with a view to the long-term and in the context of comprehensive tax reform,” Sen. Chuck Grassley (R-Iowa), one of the bill’s main sponsors, said in a statement to E&E Daily.

A spokesman for Sen. Mark Udall (D-Colo.), the bill’s other lead sponsor, said he would be open to discussing a phaseout eventually, but “We need to have a discussion first about extending before we get to that discussion.”

Some within the industry also are issuing increasingly dire warnings about the fate of the industry without a tax credit extension. The CEO of Vestas, the world’s largest turbine maker, predicted yesterday that the U.S. wind market would drop 80 percent next year because of uncertainty surrounding the tax credit, according to Reuters.

BP’s Graham said in the recent interview that his company has effectively been at a standstill because of the PTC’s potential expiration, with no turbine orders placed yet for next year.

“We can’t place any orders because we’re not clear how we could make a wind farm work next year from an economic point of view,” he said. “I would say, added to that, the customers [utilities] are kind of sitting on the sidelines also waiting to see. So there’s not a lot of demand out there at the moment.”

How it might work

Boosters of a phaseout face another obstacle in that no formal policy has been proposed yet. But outside experts offered some suggestions on how it could work in interviews this week.

Alex Trembath, a Breakthrough Institute policy associate, said a ramp-down could be based on total installations, so that the credit is reduced when the number of installed turbines hits certain milestones. Or, he suggested, the credit could be varied based on differences among wind resource classes, so that projects installed in the windiest and most transmission-accessible parts of the country get little or no subsidy, while incentives continue to support installations in more marginal areas.

Ethan Zindler, head of policy analysis with Bloomberg New Energy Finance, suggested that the “optimal design is one that phases out at the exact same pace at which the technology costs come down and natural gas prices go up, but that’s also, as you can imagine, not so easy to do.”

More practically, he suggested tasking an independent agency with setting the level of subsidy based on the latest data on the cost of turbines or the levelized cost of energy. But ultimately, he added, even a design that reduced the credit by a set amount each year would be an improvement on the current system.

“What the market needs more than anything is certainty,” he said.

Graham, of BP Wind, said he would like to see Congress provide a one- or two-year extension to provide a bridge to a broader debate over comprehensive tax reform, at which point the industry would bring to the table more ideas about how to ultimately “come off the PTC.” He suggested using a phaseout to drive increased efficiency within the industry.

“And as we reduce our costs, the PTC goes away, so you can come up with many scenarios of how that can happen. But you can essentially say from 2.2 cents, let’s work that down over a number of years to zero,” he said. “Now, the benefit of that is the industry, the businesses like us, would have a very clear line of sight to how the economics are going to work in the future years, and the industry is going to have to work to get those costs down to be successful.”

While the discussion of how to phase out the PTC is one that Congress should have, it should not be limited simply to wind, said Josh Freed, director of the clean energy program at the centrist think tank Third Way.

“In an era of constrained budgets, we need to take a look at the energy subsidy universe writ large, ask what’s in the nation’s best interest — economically, security, public health and environmentally — and how do we design funding and incentives that help accomplish this and step down as a technology proves itself able to succeed or fail in the market on its own,” he said. “Right now, it’s important to place the PTC conversation within this broader energy subsidy debate.”

Natural gas price key variable

Determining a definite endpoint for the PTC is difficult because a number of variables are at play — primarily the price of natural gas, as well as the pace of advancements in turbine technology, the cost of credit for wind developers and the broader, economywide demand for energy.

Spurred by massive new supplies unlocked by hydraulic fracturing, gas prices that have been trading as low as $2 per million British thermal units (MMBtu) in recent months have complicated wind producers’ ability to compete with natural gas-fired power plants, even though the costs of wind energy also have been falling substantially in recent years.

Graham said wind will be better able to compete as the price rebounds in the coming years. He said his company could thrive without government support if gas is trading around $5 to $6 per MMBtu in the next five to six years.

“If you look at the forward curve for gas, I think it’s $5 to $6 in five-plus years’ time. I think that’s viewed in the U.S. as reasonable,” he said. “That’s what most of the industry would like it to be, around that sort of level. That sort of level, we’re kind of in the pack.”

Other analysts have a similar view. Zindler of Bloomberg New Energy Finance predicted that wind would be competitive on an unsubsidized basis in many parts of the world by 2016, predicting that gas prices would rebound to somewhere in the range of $4 to $5 per MMBtu by that time.

Without the shale gas revolution, wind may already have been competitive in the United States, he added.

“In short, if we had the natural gas prices that we had three to four years ago today, wind would actually be in many places quite competitive, back when natural gas was up at $10 to $12 per million Btu,” Zindler said in an interview.

Continuing improvements in turbine technology are expected to drive further reductions in the costs of wind energy, increasing its competitiveness with other sources of generation like gas. Wind’s levelized cost of energy is in the range of $60 to $90 per megawatt-hour, without subsidy, compared to about $52 to $72 per MWh for natural gas, according to a recent analysis by the Breakthrough Institute, a nonpartisan think tank. The PTC brings wind’s levelized cost down to $33 to $65 per MWh, according to the study.

A recent study from the Lawrence Berkeley National Laboratory predicts further sharp declines, driven by improving turbine technology and other factors.

Trembath of the Breakthrough Institute predicts wind will soon be competitive with natural gas and said a properly designed PTC phaseout would allow wind to compete on its own while also weaning the industry off the tax-equity financing arrangements it has relied on, in which the PTC is essentially monetized in exchange for capital from large banks.

“The purpose of a phaseout would be both to encourage incremental improvements in the cost of wind turbines and also to phase the industry off of the traditional form of project finance that they have gotten used to over the past 20 to 30 years since the creation of the production tax credit,” he said.