Friday, June 02, 2006

Tacking Against the Wind

While catching up on last week's Wall Street Journal op-eds, I was surprised to see one that was highly critical of the proposed Cape Wind project in Nantucket Sound. I've written several postings on this project, mostly focused on what I saw as the inconsistency of the opposition, which seemed to focus more on aesthetics than on the economic or environmental benefits it could bring. William Koch's opinion piece (subscription may be required) should be mandatory reading for anyone interested in alternative energy projects, either pro or con. It views the offshore wind farm in purely economic terms, and the result is highly instructive.

Mr. Koch knows more than a thing or two about energy projects. Aside from being a member of the family that founded Koch Industries, one of the largest privately-owned energy companies in America, he has been a major energy investor in his own right for decades. The fact that he was personally invited to invest in Cape Wind and apparently owns property in the area lends added spice to the story.

If you can access the article, you'll read a detailed economic breakdown of the projected costs, returns and risks of Cape Wind. Mr. Koch concludes his analysis with a firm rejection of the project on its merits. The issues he addresses must be factored into any serious long-term energy policy for this country. First, he identifies the financial exposure created by the failure of the Congress and states to provide alternative energy incentives of a duration matching the investments. A major capital project such as an offshore wind farm requires many years to pay out; a wind tax credit that is renewed on a year-by-year basis just doesn't meet the investors' and developers' needs. (The same is true of a solar credit in California, under which PG&E is already approaching the 0.5% of capacity cap on solar power purchases.)

We also see the impact of the protracted delays this project has experienced, due to local opposition. Slipping 2 or 3 years would severely impair the returns of a conventional energy project, such as an offshore oil platform, because the first revenues arrive so long after the first investment is made. Cape Wind may be even worse off, as its construction costs skyrocket in the midst of a global boom in construction materials, while the approval process drags out. According to Mr. Koch, a project that could have been built a couple of years ago for well under a billion dollars would now cost roughly 100% more. Moreover, he suggests that the local grid is awash in excess capacity, indicating that power from Cape Wind might not even be dispatched at the prices it would have to charge to make a profit. This is a truly devastating critique.

I'm sure the developers of Cape Wind will respond with their own figures. Things may not be quite so bleak, and I suspect they would not regard Mr. Koch's comparison to a coal-fired alternative as truly equivalent to offshore wind power. The price of natural gas has also more than doubled in the four year interval that Mr. Koch considered, raising the costs of wind's nearest real competitor. But the message here is clear: if we want the private sector to step up the pace on alternative energy, these projects must pass the same sort of business criteria as conventional energy projects. So if they depend on government incentives, then those incentives must last at least as long as it takes to generate a return on investment that exeeds government bonds. They should also be approved or rejected promptly, to keep attractive up-front economics from being drained away by opposition groups, rather than through exposure to the market risks that any energy project must withstand.

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