Once all of the influencing factors ina wind power project are identifiedand quantified, the developer and

investor must then fully understand andmanage those risks. Moreover, certain riskfactors may be more significant to one proj-ect stakeholder than they are to another.With a robust financial modeling tool eachrisk in a project can be best evaluated andaddressed to maximize project returns.

Risk managementWind power project risks can be classifiedinto the following categories:1. Development and construction risks

encompass all aspects of installing windturbines

2. Financial risks relate to the terms andavailability of financing options

3. Production risks include wind variability,efficiency losses and curtailments

4. Operational risks include maintenancecosts over the lifetime of the project

5. Regulatory risks involve permitting,changes in laws and changes in tax benefits

The relative importance of these categorieswill vary throughout the life of the project:early stage investors will face greater develop-ment, construction and financing risks, whileproduction, operations and regulatory riskswill extend throughout the life of the project.(Table)

Some risks can be more quantifiable than others, and some risks can be managedor hedged. Others are more difficult to man-age. For example, substantive risks that areoutside the control of the owner include:

1. In the United States, legislation thatpassed in November of 2004 extend-ed Production Tax Credits (PTCs) for another year, and while the recent Energy Bill approved by theSenate extends the credits for 3 additional years, uncertainty relative to the long term availability of PTCs has delayed projects and has prevented turbine manufacturers fromexpanding production and new manufac-turers from entering the market. Thishas resulted in higher turbine prices andan inadequate turbine supply.

2. Wind and weather profile variability.While seasonal and annual wind profilestend to follow patterns, deviations fromthese expected patterns inevitably occurand can have a severe impact oninvestors' returns.

These types of uncertainties are clearlymore difficult to quantify and model.Examples of risks that can often be modeledand managed include:1. Electric sales prices

2. O&M costs with support of manufactur-ers' warranties and a well-planned main-tenance program

3. Financing costs

Sometimes owners may have to pay a mar-ket premium to hedge these risks, but thepremiums can enable more predictable resultsand better ensure access to competitivefinancing. Theoretically, it is possible tohedge against wind variability using windinsurance products, although the market forthese products may be too shallow or simplynot cost competitive.

Other factors that affect electric produc-tion are modeled with varying levels of pre-dictability. Wind turbine manufacturersoffer warranties for turbine efficiency (powercurve accuracy) and availability, providingassurance of these variables in the early yearsof a project. On the other hand turbine bladedegradation and electrical efficiency lossesover the life of the wind farm, while fairlypredictable, are not warranted and so becomean owner's risk. Similarly, market factorssuch as curtailment by the utility and otherscheduling risks can also produce uncertainty.Past experience can provide a general bench-mark for other operational issues such as site

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Project economic modeling has come a long way over the years.Yet, stakeholders continue to wrestle with the methods to bestquantify and manage the myriad operational and financial risksembedded in energy projects. Wind power projects in particularinvolve many factors that require sophisticated financial analysistools for a complete project assessment. Matt Coleman andSteve Provol of Competitive Energy Insight, Inc., report.

WIND POWERECONOMICSUnderstanding Economic Risks in Wind Power Projects in the USA

Further InformationContact: Matt Coleman,Competitive Energy Insight, Inc,;Tel: +1 310 804 2727; Email:mcoleman@ceinsight.com, or SteveProvol, Competitive Energy Insight,Inc, 12025 Blue Diamond Court,San Diego, CA 92131, USA; Tel +1858 566 0221;sprovol@ceinsight.com; www.ceinsight.com

maintenance, operations management, andasset management, but these are also risksthat are the owner's responsibility. Whilewind turbines are proving to be more reliablethan they were a decade ago, current technol-ogy does not yet have a 20-year track recordcalling into question the accuracy of factorssuch as gearbox, generator and blade repairsduring the outer years of the asset life.

Risk allocationResponsibility for and allocation of risks arecrucial to contract negotiations. The bestarrangements assign financial responsibilityfor risks to the party or parties with the bestability to manage them. Assigning risks canbe further complicated by transactiondynamics where cash flows in certain yearsare more important to some investors than toothers. For example, in a "flip" deal structure,disproportionate allocation of tax benefitsand cash flows can have a heavy influence onthe allocation of risk to the various partiesinvolved in a wind farm transaction. Giventhe short duration of typical warranties, post-warranty expenses comprise a majority oftotal project lifetime expenses, but also withthe flip structure the post-warranty expensesand cash flows will clearly be more importantto the investors who receive the majority ofincome allocations in the latter years.

Examples of Project RiskAnalysisFigure 1 illustrates the typical distribution ofoperating expenses over the life of a windproject in the United States. In the earlyyears of the project, debt service is the mostsignificant project expense while the tax shel-ters of depreciation and PTCs result in a nettax benefit rather than an expense to the proj-ect. Also in the early years, some of the main-tenance expenses can be deferred to war-ranties, but as the warranties expire the ownerassumes an increasing liability for thoseexpenses, whether planned or unplanned.

For wind projects that are tied to utilityrates or to other power pricing mechanismsthat are not fixed, owners may be faced withexposure associated with changes in powerprices. For example, the proportion of revenues derived from utilities from year toyear can shift between fixed (demand /capacity related) and variable (energy pro-duction related) categories. Since wind

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Risk Category Easier to Predict Harder to Predict

Development/ Domestic wind turbine costs Availability of wind turbinesConstruction Substation, electrical costs Exchange rates

Financing Cost of equity Financing terms and covenants Interest rates Tax equity availability

Production Wind turbine availability Wind speed variabilityWind turbine power curve

Operational Warranty O&M Post-warranty O&MGear-box failures in outer years

Regulatory PTC escalation PTC availabilityChange in tariffs or avoided costs

Table: Risk Management Examples

Figure 1: Sample of Wind Project Operating and Financial Expenses

Figure 2: Sensitivity of NPV of Energy Prices for the Example Case Project - Base Year 2005 $

projects do not typically receive much if anycapacity payments, these shifts can have a dra-matic effect on revenues from energy sales.Figure 2 illustrates the sensitivity of the sam-ple project's net present value (NPV) to ener-gy price. In this example a 15% reduction inenergy price will essentially cut the project'sNPV in half while conversely, profits can bedramatically improved by higher energyprices.

Another advantage that a computer modelbrings to the user is the ability to automati-cally analyze the variance of multiple param-eters. Figure 3 presents an illustration of a Tornado Diagram, a valuable tool for evaluating the relative impacts of manyparameters on the economics of a project.Tornado Diagrams portray the relativeimpact on project returns of several differentvariables ranked in order of greatest to leastimpact. In the IRR Tornado Diagram pro-vided in Figure 3, each input was varied overan assigned range of potential risk uncertain-ty. Positive impacts are charted to the right ofthe centre vertical axis, with negative impactscharted to the left. The parameters and theranges studies are shown on the left axis. Inthis example electric production (varied +/-10%) was the most sensitive parameter, aswould be expected for a typical wind project.A 10% reduction in electric productionreduced the project's after-tax internal rate ofreturn (IRR) from 13.4% to 10.6%. Nextmost significant is the energy price (varied+/- 15%), covering the same range as shownin Figure 1, followed by construction cost

and the corresponding investment requiredto fund the project.

Another important factor is the proportionof debt (or leveraging) used to finance theproject. Also, the PTC escalation rate is anoth-er key variable that could vary greatly becauseit is indexed to the GDP Implicit PriceDeflator, which in this example was studiedover a range of +/- 100% times the currentescalation rate of about 1.5% per year. Lastlywe illustrate O&M expenses, with warrantyO&M varied by +/- 15% and post-warrantyO&M varied by +/- 30%. Even though thepost-warranty costs are not a factor until sever-al years into the project, they still have anoticeable effect on the project's returns.Figures 1 - 3 provided in this article are out-puts from the Econ-Expert-WIND financialmodel, an Excel-based tool for the evaluationof investments in wind farm projects (seewww.CEInsight.com).

Project versus PartnerReturnsIn the United States today many wind powerdeals choose the legal form of a limited liability company (LLC). The entitythen elects to be treated as a partnership andfollows Internal Revenue Service partnershiptax law. The language in the partnershipagreement governs the flow of income andexpense items through the partners' capitalaccounts as well as items such as guaranteedpayments that are not capital account items.Moreover, the agreement can be structurednumerous ways regarding distributions of cash

or property back to the investors. Capitalaccounts represent the accounting of eachindividual investor's history with the company(e.g. capital contributions, annual income allo-cations and return distributions)

Partnerships are flow through entities andtherefore all items of partnership income andexpense, depreciation and production creditsare reflected on each partner or investor's sep-arate account. This is in contrast to the taxtreatment of a regular corporation, and hencepartnership financial statements can be sub-stantively different and so can the resultingallocation of risk amongst the various partners.While production tax credits do not directlyaffect partners' capital accounts, someone whoknows the tax laws should review their alloca-tions. Please note that this brief description ofpartnership tax issues is not intended to belegal advice and that all stakeholders in arenewable energy partnership or LLC shouldseek professional tax advice.

ConclusionsWith risk considerations in mind, the value ofsophisticated project financial modeling toolsis clear. These risk issues become further com-plicated by the partnership and tax allocationstructures applied in any power project, fur-ther emphasizing the importance of an ade-quate financial model. With proper analysisthe disciplined and savvy developer, taxinvestor or owner who takes the time to under-stand, evaluate and manage risks, can maxi-mize the likelihood of exceeding a project's target returns.

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Figure 3: Consolidated Tornado Diagram After Tax IRR Base Case Leveraged IRR= 13.4%