The current article aims to highlight the key aspects of wind power projects. After reading this article, an investor would understand the factors that impact the business of wind power plants and the characteristics that differentiate a fundamentally strong wind power plant from a weak one.
Key factors influencing the business of wind power plants
1) Large land requirements:
Wind power plants are one of the most land-consuming projects. The land requirement for a wind power plant is much more than other forms of power like thermal power as well as solar power.
As per some estimates, a wind power plant may require up to 200 times more land to provide a power output similar to a thermal power plant based on natural gas.
Land Use Requirements of Solar and Wind Power Generation by Paul Saunders, November 2020, page 1:
Fossil fuels and nuclear generation are vastly more power-dense than renewables; natural gas, for example, is roughly 80 times more power dense than solar power and 200 times as dense as wind.
Wind power projects are able to achieve a plant load factor (PLF) of only about 25%-30% in comparison to the PLF of more than 85% for conventional power plants. As a result, up to 3-4 times more wind power generation capacity is needed to replace every MW of conventional power plant, which leads to a larger land requirement.
Criteria for rating wind power projects by CRISIL, June 2015, page 4:
The inter-annual variability of wind power projects is measured by standard deviation, which is typically 4 to 6 per cent at a P50 PLF of 25 to 30 per cent.
Another factor leading to a large requirement for wind power plants is the mandatory minimum spacing between wind turbines because every turbine produces an area of low speed and high turbulence behind it, called a wake, which interferes with the other nearby turbines. Therefore, wind turbines are installed at a distance from each other increasing the land requirement.
Global Methodology for Rating Wind Power Projects by DBRS Morningstar, September 2022, page 29:
Turbines are typically spaced 200 metres to 800 metres apart, and large wind farms can span 20 kilometres to 30 kilometres in each direction.
As a result of large land requirements, land acquisition and related approvals become a key risk in the execution of wind power plants, which take the maximum time among all the activities.
Rating Methodology: Wind Power Projects by CARE, August 2020, page 2:
Land acquisition & related approvals are considered to be very critical for timely implementation of wind power project as this activity usually takes maximum time in the entire implementation schedule of the wind power project.
In fact, problems during land acquisition were proving an obstacle to the rapid expansion of renewable power generation in the country. There were instances where issues in the land acquisition led to delays in
Rating methodology for wind power producers by ICRA, July 2021, page 2:
the developers have faced delays in the past…completing land acquisition, leading to delays in project implementation.
In FY2019, the pace of wind power addition was reduced because many power producers face challenges in land acquisition and therefore, they could not complete their projects in time.
Rating Methodology for Wind Power Producers by ICRA, July 2019, page 1:
actual execution on ground remained slow in FY2019, because of delays in completing land acquisition and securing transmission connectivity.
To solve such problems, the govt. came up with Govt. Wind Parks that provide land ready with all the approvals to developers who can straightway start installing the equipment to generate wind power.
Such govt. wind parks have significantly reduced the risk related to land acquisition for renewable power projects.
Rating Methodology: Wind Power Projects by CARE, August 2020, page 2:
Government Wind parks offer a plug and play model with availability of land, shared infrastructure and all the related approvals
Therefore, an investor may note that wind power plants proposed inside govt. wind parks have a much lower land acquisition risk than the plants outside.
However, even for the projects outside such renewable energy parks, the govt. has tried to reduce the approvals risk by waiving environmental clearance for wind power projects.
Rating Methodology for Wind Power Producers by ICRA, July 2021, page 2:
the permitting risk for a greenfield wind power project is lower than that of thermal or hydro-based projects, given the exemption from environmental and forest clearance (except in case of use of forest land)
Therefore, an investor would appreciate that the govt. is providing support for rapid expansion of renewable energy production including wind power generation.
Advised reading: How to do Business Analysis of Thermal Power Plants
2) Low project construction and execution risk:
Wind power projects are easy to implement i.e. construct and operate. This is because the construction of the wind power plant is simply installing a tower with a turbine at the top with rotor blades. Over time, companies have excelled in constructing stable towers for wind power projects and the technology of wind turbines has stabilized.
In fact, the technology of wind power plants is more established than solar power plants.
Advised reading: How to do Business Analysis of Solar Power Plants
Rating Methodology: Wind Power Projects by CARE, August 2020, page 3:
Wind turbine (which consists of three main parts viz. blades, shaft & generator) is the critical component of a wind power project and it is quite an established technology when compared with solar power project.
As a result, most wind power projects are completed within time.
Rating criteria for wind power projects by CRISIL, June 2021, page 28:
Design and construction risks in wind power projects are negligible. Wind power projects have a proven track record of timely execution across several installations.
The only problems faced by wind power plants in their construction are land acquisition (discussed above) and the availability of the power transmission line from the project site to the nearest grid substation, which can transfer the power produced by the wind power plant to the electricity grid.
Rating criteria for wind power projects by CRISIL, June 2021, page 28:
However, land availability and power evacuation issues due to delays in commissioning transmission lines could pose a major challenge for timely completion.
The risk of non-availability of the transmission line from the wind power plant site to the grid substation is very critical because the absence of it may lead to a wind power plant that is ready to produce electricity but cannot because the electricity cannot be transmitted to its customers.
Rating Methodology for Wind Power Producers by ICRA, July 2021, page 2:
The critical approvals required for a wind power project include the approval for transmission connectivity to the designated sub-station and long-term open access for supply of the power generated to the grid (state / inter-state network).
The location of wind power plants in a remote location away from the existing grid substations increases the resource requirements for installing the power transmission line. As a result, in India, the speed of creation of power transmission lines is slower than the pace of the addition of wind power generation capacity.
Rating Methodology: Wind Power Projects by CARE, August 2020, page 3:
Transmission line availability and access risk is high for renewable energy especially with wind and solar projects compared to traditional power projects…Pace of expansion in transmission infrastructure is lagging compared to faster pace of wind capacity addition in India.
On its part, the govt. has attempted to reduce the risk of non-connectivity by promoting govt. wind parks with readymade power transmission connectivity, which reduces the implementation risk for wind power plants.
Rating Methodology for Wind Power Producers by ICRA, July 2021, page 2:
renewable energy parks, which provides a developed land plot with clearances and associated infrastructure including grid connectivity, the permitting risk is relatively lower than that for a greenfield project at locations outside the renewable energy park.
Once a wind power plant has overcome land acquisition and power transmission risks by either choosing to locate inside a renewable energy park or completing these activities within timelines, then the construction of wind power producing towers and other related infrastructure is simple without many difficulties. Though, the construction risk is a little higher in the case of offshore wind power plants constructed within the sea away from the shore.
It is advised that wind power developers should stipulate about a 30% increase in costs and a delay of about 6 months in project completion when they make their project estimates.
Power Generation Projects Methodology by Moody’s, January 2022, page 26:
liquidity (see description below) would generally need to be sufficient to withstand an approximate cost overrun that is 30% of the EPC contract price and a six-month delay in completion.
Due to advancing technologies, operating a wind power plant is also a simple exercise where the wind turbines start automatically when the wind speed reaches an optimal level and automatically shut off when the wind speed exceeds safe operation levels. As a result, operations and maintenance costs are about 15%-20% of revenue leading to a high operating profit margin for the wind power plants.
Global Methodology for Rating Wind Power Projects by DBRS Morningstar, September 2022, page 11:
O&M costs are typically between 15% and 20% of revenue
European Utilities: Renewable Energy Corporates Rating Methodology by Scope Ratings GmbH, January 2022, page 7:
hydro, wind, solar and geothermal power generation, tend to have EBITDA margins of between 50-85% with very little volatility
The maintenance expenses of offshore wind power projects are nearly double those of onshore wind power projects.
Global Methodology for Rating Wind Power Projects by DBRS Morningstar, September 2022, page 33:
Overall, O&M costs are expected to be in the range of USD 30/MWh to USD 55/MWh (offshore) compared with USD 15/MWh to USD 25/MWh (onshore).
If maintained properly with periodic replacement of parts, wind power plants can have a life of up to 30 years with a stable performance.
Global Methodology for Rating Wind Power Projects by DBRS Morningstar, September 2022, page 15:
Wind turbines have asset lives of up to 30 years and, except for periodic replacement of turbine blades and occasional replacement of other components, generally achieve stable performance of their respective power curves over the asset life.
Advised reading: Operating Performance Analysis: A Simple & Complete Guide
3) Capital-intensive nature of business:
In India, it costs about ₹6.8 cr to ₹7.2 cr per megawatt (MW) to construct a wind power plant (Source: Businessinsider). Having large wind power plants is a fairly capital-intensive activity requiring a large amount of funds.
Rating Methodology: Wind Power Projects by CARE, August 2020, page 1:
Wind power projects are capital intensive in nature and for funding them, recourse to publicly issued debt would be necessary.
The capital-intensive nature of wind power plants acts as an entry barrier for large-sized power, which adds a meaningful power generation capacity. Otherwise, wind power production is highly fragmented with numerous players producing energy by installing a single wind power turbine.
European Utilities: Renewable Energy Corporates Rating Methodology by Scope Ratings GmbH, January 2022, page 5:
entry barriers to the industry, which are imposed by the high capital intensity of power generation assets and by regulations….entry barriers for new competitors in the area of fully regulated power generation to be high and entry barriers for competitors for IPPs which sell at market prices to be medium.
Offshore wind power project costs almost double of onshore wind power projects due to additional features to protect against degradation of equipment due to harsh environment.
Global Methodology for Rating Wind Power Projects by DBRS Morningstar, September 2022, page 33:
Capital cost of offshore wind power is still nearly twice that of onshore wind energy projects
The cost of construction of offshore wind power projects increases because the developers need to install backup equipment on the site, which can quickly come into action when any part of the plant breaks down. Keeping backups on the site is essential because of difficulties in quickly replacing damaged parts in the middle of the sea.
Global Methodology for Rating Wind Power Projects by DBRS Morningstar, September 2022, page 33:
Redundancy is crucial for offshore wind in order to avoid a major interruption in generation and transmission. Backup transformers and equipment are important to ensure reliability and carry capacity to the mainland.
Due to large capital requirements, wind power plants need a lot of debt. Usually, developers opt for a debt-to-equity ratio of 3:1 for funding wind power projects.
Rating Methodology: Wind Power Projects by CARE, August 2020, page 6:
As a normal trend, wind projects are financed at a debt equity ratio of 75:25.
The presence of a large amount of debt brings in additional risk if the terms of the debt are not aligned with the cash flow pattern of the wind power plant. This risk is especially high for wind plants where the tenor of the debt is low e.g. less than 10 years, as the plant may not generate sufficient cash for debt servicing and the plant will face refinancing risk.
If the wind power plant has a long tenor of debt e.g. 15-20 years, which normally corresponds to the life of the plant, then the plant would be able to repay its debt without significant challenges.
Rating Methodology: Wind Power Projects by CARE, August 2020, page 7:
Loan from banks / FIs for financing of a wind project are available for a tenor of maximum up to 17-18 years which largely corresponds to the project life…whereby there would be largely no refinancing risk. However, when a wind project is funded by some loans and/or capital market instruments for a tenor of say 3 / 5 / 7 / 10 years, it is exposed to the refinancing risk for varying degree.
Therefore, the terms of the debt are an important aspect of the financial performance of the wind power plant.
Advised reading: How to do Financial Analysis of a Company
4) Seasonality in production and high working capital needs:
Wind power production fluctuates significantly with seasons. The production is maximum in the monsoon months and declines in other seasons.
Rating Methodology: Wind Power Projects by CARE, August 2020, page 5:
Electricity generation through wind power is also subject to seasonal variations, i.e., wind generation usually peaks in monsoons and bottoms during the other seasons; accordingly, there would be no linearity in power generation by a wind project during the year
The seasonal variation in wind power generation is much more than in other forms of power including solar power generation. About two-thirds of power generation by wind power plants is concentrated in the peak season of 3-5 months.
Rating criteria for wind power projects by CRISIL, June 2021, page 29:
Typically, the peak wind season is of 3-5 months while the lean season is for the rest of the year. Around two-thirds of the annual production is in the peak season. Thus, in the lean season, the project PLF and revenue generation will be much lower than the annual average.
Due to seasonal variations in power production, the money available with the wind power plant to meet its operating expenses and debt servicing fluctuates significantly during the year. However, the expenses, primarily debt servicing, are constant throughout the year. As a result, the wind power plant faces a cash flow mismatch between the inflow and outflow during different seasons.
Rating Methodology: Wind Power Projects by CARE, August 2020, page 7:
As power generation from a wind project is seasonal in nature & there exists counter party delayed payment risk, CARE considers that adequate liquidity back-up as an important rating consideration as debt repayments are normally evenly spread out (monthly/quarterly basis).
To mitigate this cash flow mismatch, a wind power plant needs to maintain sufficient excess liquidity so that it can meet operating and debt-related outflows without any problems. It increases the working capital requirements for the wind power project.
Normally, a wind power plant needs to maintain an extra reserve of 3 to 6 months of debt repayment (debt services reserve account, DSRA) due to the seasonal variation of power production.
Rating Methodology: Wind Power Projects by CARE, August 2020, page 7:
For a wind project, liquidity back-ups are created primarily in the form of DSRA which cover 1-2 quarters debt repayment obligations in the form of FD / bank guarantee / working capital limits
High liquidity backups put pressure on the returns that wind power plants can generate from their investments. Therefore, some wind power developers do not maintain sufficient liquidity buffers, which increases the risk of the project.
Rating criteria for wind power projects by CRISIL, June 2021, page 30:
Given the inherent risks in the sector and the economic considerations where the developer may want to generate reasonable returns on the investment, the project DSCR and liquidity are unlikely to be substantially high.
Moreover, many times, to increase returns, wind power plant developers appoint low-cost, weak contractors for operations & maintenance (O&M). This increases the risk for the wind power plant significantly because of the high seasonality. If due to poor maintenance, the wind power plant stops working in the peak season, then it can impact the overall power generation by the plant for a year.
Rating Methodology: Wind Power Projects by CARE, August 2020, pages 4-5:
power generation from the wind power project is highly concentrated in few months only whereby proper availability of the plant is critical.
A weak O&M agency increases the risks of suboptimal performance of the power plant because moving parts in a wind power plant require more maintenance, unlike a solar power plant.
Rating Methodology: Wind Power Projects by CARE, August 2020, page 4:
Due to few moving parts in wind turbines, proper O&M is critical for sustained power generation from the project.
Therefore, if a power plant hires a weaker O&M agency, then it may need a replacement of the O&M agency later on, which would involve additional costs.
Renewable Energy Project Rating Criteria by Fitch Ratings, August 2021, page 5:
We consider operator agreements that appear under-priced or are with a counterparty of weak credit quality to be credit negative, as the operator may have to be replaced with a higher-cost third-party operator in the future.
Advised reading: How Companies Inflate their Profits
Therefore, investors should be cautious of wind power plants showing very low O&M expenses due to the hiring of cheaper agencies.
In addition, wind power plants may decide to increase returns on investment by keeping a lower than required liquidity for operating expenses, debt servicing as well as major maintenance reserve (MMR). However, an investor may note that these liquidity reserves are necessary. Moody’s penalises wind power plants, which do not provide enough money as a major maintenance reserve (MMR) with a lower credit rating.
Power Generation Projects Methodology by Moody’s, January 2022, page 22:
Depending on the severity of the project’s expected maintenance profile and major maintenance cost outlays, the lack of an adequate MMR may result in a one-half to whole notch downward adjustment.
Renewable Energy Project Rating Criteria by Fitch Ratings, August 2021, page 5:
Fitch considers whether there is a major maintenance reserve to cover the cost of major repairs and overhauls.
The presence of liquidity buffers and maintenance reserves becomes important for wind power plants because generally, wind power plants underperform their projected performance levels.
Global Methodology for Rating Wind Power Projects by DBRS Morningstar, September 2022, page 6:
Wind projects have historically been vulnerable to underperformance relative to base- case power production forecasts.
Advised reading: Operating Performance Analysis: A Simple & Complete Guide
5) Power offtake and payment risk:
In the normal course of events, in India, we hear a lot about the auctions for wind power production conducted by organisations like Solar Energy Corporation of India (SECI) and NTPC Limited (NTPC) where these agencies act as power purchasers on behalf of distribution companies. These are the auctions, which have seen very aggressive biddings by wind power plant developers and the per-unit cost of wind power has declined below conventional sources of power like thermal power.
Rating Methodology for Wind Power Producers by ICRA, July 2019, page 1:
The wind power tariffs discovered through the reverse auction process is lower than the generation cost from conventional sources such as coal and gas-based generation stations.
SECI and NTPC assure purchasing the entire power produced by the auctioned wind power production capacity at the bid price. However, wind power plants face situations where the plant is ready, the transmission line is ready; however, the customer/off-taker is not drawing/buying power from the wind power plant i.e. called grid curtailment risk.
Rating Methodology: Wind Power Projects by CARE, August 2020, page 8:
Delay in availability of evacuation infrastructure for under implementation projects, inadequate capacity of sub-stations leading to power curtailment issues once the project is operational.
Indian govt. supports renewable power production including wind power by imposing renewable purchase obligation (RPO) on distribution companies, which obligates them to buy whatever renewable power is produced. Theoretically, it creates a situation where each unit of power produced by wind power plants would always find a buyer.
However, wind power plants face problems in selling power to distribution companies (discoms) as the discoms do not buy wind power despite being obligated to do so.
Rating Methodology for Wind Power Producers by ICRA, July 2021 page 6:
A weak compliance of the RPO norms by obligated entities, coupled with inconsistencies in the RPO norms by the SERCs, affect the demand for renewable energy
Apart from these challenges in the offtake of the power produced by wind power plants, they also face issues in getting the contracted price of the power even if it is fixed in the long-term power purchase agreement (PPA) signed by the discom with the wind power plant. This is especially true in the case of older wind power plants, which got commissioned when the price of wind power was comparatively higher and subsequently, the tariff of power from newer wind power plants witnessed a significant decline.
These old wind power plants face immense pressure from discoms and there have been attempts by discoms to renegotiate prices in line with current prices or attempts to get out of the contracted PPAs.
Rating Methodology: Wind Power Projects by CARE, August 2020, page 8:
Honoring of the executed PPAs by the off-takers; few instances of state Discoms asking for renegotiation of tariff in concluded PPAs have been observed. Any renegotiation of PPA tariff rate or tenure of PPA could materially change the project dynamics and its debt servicing capability
This resistance of customers (discoms) to pay the contracted price and attempts to renegotiate/exit the PPA is especially higher in those PPAs, which are signed at a price, which is much higher than the current ongoing wind power price.
Power Generation Projects Methodology by Moody’s, January 2022, page 11:
If the contract is materially above the market based on the contract terms…, the off-taker has less incentive to work with the project in a constructive manner to resolve any operational or technical problems that arise… Similarly, if there is limited regulatory support, for instance if the project sells to a utility whose regulator does not permit the pass-through of project costs to ratepayers, the off-taker has greater incentive to find ways to exit the contract.
Therefore, if an investor comes across a wind power plant enjoying a very high selling price of its wind power as per the original PPA signed in the past, then she should not think that these high prices would continue without any resistance from the customer. Soon, she might find that the customer has started creating issues in off-taking the power from the said power plant. This increases the repricing risk for the power plant.
Rating Methodology for Wind Power Producers by ICRA, July 2021 page 6:
While the PPAs are contractual documents, instances of attempts to re-negotiate the PPA terms unilaterally have been seen recently, resulting in prolonged legal & regulatory proceedings.
Apart from the above-mentioned challenges in power offtake, wind power plants also face delays in getting payments for the power sold to the discoms. This is due to the weak financial position of most of the state discoms.
Rating Methodology: Wind Power Projects by CARE, August 2020, page 6:
barring a few state Discoms & central agencies, majority of the state Discoms in India have a weak financial profile and they demonstrate delayed payment track record for varying period of delays which typically constrain the rating for a project.
Advised reading: Receivable Days: A Complete Guide
Therefore, wind power plants need to maintain additional liquidity to meet their operational and debt servicing cash outflows when their payments from discoms are delayed.
Rating Methodology: Wind Power Projects by CARE, August 2020, page 7:
The higher the delay by the counter party, the greater the liquidity buffer the developer needs to maintain to curtail the off-taker payment risk.
As a result, those wind power plants, which have contracts with central bidding agencies like SECI and NTPC are considered better than those having PPAs with state discoms and commercial & industrial (C&I) customers.
Rating Methodology for Wind Power Producers by ICRA, July 2021 page 4:
PPAs with central nodal agencies are viewed more favourably compared to the PPAs with state distribution utilities and C&I customers, due to factors such as adequate payment security mechanism and tripartite agreement benefit for realising payments from discoms.
Further advised reading: How to analyse New Companies in Unknown Industries?
6) Very high, long-term counterparty risk with customers (discoms):
Wind power plants enter into very long-term power purchase agreements (PPAs) with their customers extending up to 25 years
Rating Methodology: Wind Power Projects by CARE, August 2020, page 5:
In case off-taker is state Discoms / central agency like SECI / NTPC / NVVN, PPA is executed for a period of 20-25 years, whereas in case of third-party off-taker, PPA is executed for a period of 3-15 years.
Once a PPA is signed, the wind power plant or the customer cannot exit the contract easily. Therefore, the wind power plant has to suffer if over the next 25 years the financial position of the customer/off-taker/discom deteriorates.
Rating Methodology: Wind Power Projects by CARE, August 2020, page 5:
Counter party risk could significantly impact the credit quality of the project as there is long-term tie-up of the project with off-taker with minimal chances to move out of it… Predicting the quality and behavior of off-taker for a reasonably long period of time as long as up to next 20-25 years is very difficult.
On the contrary, if the wind power producers think of entering into shorter tenure PPAs, then they face the pricing risk where the price of the new/renewed PPA may be lesser, which may make old wind power plants economically unviable.
Rating criteria for wind power projects by CRISIL, June 2021, page 32:
if the current tariff considerably exceeds the prevailing market rate, the project will be exposed to renewal risk once the PPA expires. Therefore, the higher the current tariff from the market rate, the greater the project’s risk exposure.
The obligations and guarantees of the equipment supplier are relatively less stringent for wind power projects in comparison to solar power projects. Wind power projects usually have warranties for about 2 years unlike solar panels, which have performance warranties extending up to 20 years.
Global Methodology for Rating Wind Power Projects by DBRS Morningstar, September 2022, page 9:
Warranties are usually offered for a two-year period and encompass defects in workmanship and installation. In projects involving a new generation of turbines, longer warranties are typically offered…. Teething issues are typically addressed in the first two years.
Nevertheless, the performance of the wind power plant undergoes deterioration of about 2%-3% every year.
Global Methodology for Rating Wind Power Projects by DBRS Morningstar, September 2022, page 14:
Turbine performance adjustments for field conditions can be between 2% and 3%, icing between 0.5% and 1.0%, and blade degradation between 0.5% and 1.0%. These are annual levelized adjustments and not cumulative reductions in production that grow over time.
However, offshore wind power plants suffer a higher degradation in performance and witness lower plant availability for power generation.
Global Methodology for Rating Wind Power Projects by DBRS Morningstar, September 2022, page 33:
Offshore wind turbines generally have lower availability than onshore and may have higher degradation in performance.
Further advised reading: Credit Rating Reports: A Complete Guide for Stock Investors
7) Diversification:
Wind power plants are exposed to risks of natural events like heavy rains, floods, storms etc., which impact power generation. A wind power generation company with plants in different geographical locations is relatively protected from such natural disasters.
European Utilities: Renewable Energy Corporates Rating Methodology by Scope Ratings GmbH, January 2022, page 7:
The more diversified the power generation assets of a renewable energy company’s portfolio are, the lower the risks of a significant deterioration in the company’s cash flow in the event of unexpected weather conditions, disruptions in power generation operations, or the volatility of cost structures
Wind power plants face a strong counterparty risk from their customers as PPAs are contractually binding agreements where in the case of non-performance, it takes a lot of time and resources to get out of the agreement. As a result, non-performance by the customer/discom/off-taker is a serious risk for a wind power plant, which gets reduced if a plant has tied up with many different customers/off-takers.
Rating criteria for wind power projects by CRISIL, June 2021 page 32:
Portfolio diversification, through geographical and counterparty diversification, helps reduce risk. For wind farms spread across different locations, the farther the locations are from each other, the lesser will be the correlation between their wind speed patterns… Diversification with regard to counterparties tends to reduce payment risks.
8) Market risk and cyclicity:
Most wind power plants get an assured price of the power produced by them (the bidding price) for their life along with an assured offtake of the entire power produced by them due to renewable purchase obligation (RPO). These power plants do not face any market risk or price risk because both the demand and the price for their power are fixed.
However, there are other wind power plants, which do not have long-term and fixed-price PPAs. These plants face a significant market risk because the demand as well as the price for their power is not fixed and depends on market forces of demand and supply.
Wind power plants, which have short-term PPAs also face the market risk at the time of renewal of PPA because the new PPA would be priced according to the then prevalent market situation. Wind plants with PPAs stipulating variable prices based on some formula are also exposed to market risk.
Another set of wind power plants, which receive payment of their power in the form of renewable energy certificates (REC) is also exposed to market risk because the price of RECs fluctuates based on their demand and supply.
Rating Methodology for Wind Power Producers by ICRA, July 2021 page 7:
For projects based on the REC route, returns remain exposed to the market risks associated with the REC demand and pricing.
If the wind power plants do not have an assured offtake for their power via PPAs and renewable purchase obligation (RPO), then the purchase of their power is influenced by the situation of the general economy. These power plants face alternate phases of high and low demand based on the stage of the boom and bust phases of the economic cycles.
European Utilities: Renewable Energy Corporates Rating Methodology by Scope Ratings GmbH, January 2022, page 5:
For renewable energy corporates which sell at fully regulated long-term tariffs, Scope regards exposure to cyclicality to be low. In contrast, renewable energy corporates which sell at market prices may face high volatility from market prices. Project developers generally face high cyclical exposure
Advised reading: Margin of Safety in Stock Investing: A Complete Guide
9) Social and regulatory risk:
As discussed earlier, wind power plants require large parcels of land. As a result, the land acquisition process has social consequences.
Rating Methodology for Wind Power Producers by ICRA, July 2021 page 11:
There have been challenges in completing land acquisition, and social risks manifest when there are disagreements over compensation between the developers and the land owners.
There have been multiple instances when the land acquisition process has led to social unrest. Sources:
- Land conflicts on the horizon as India pursues a clean energy future
- Residents of Gujarat village protest against windmills being set up on forestland
- Suzlon’s Kerala land use is deemed ‘trespass’
Therefore, an investor should be cautious of these social aspects of wind power plants before doing their due diligence.
Wind power plants are exposed to high regulatory risk. This is because regulations related to land acquisition, renewable purchase obligation (RPO) etc. have a huge impact on the performance of wind plants.
Rating Methodology: Wind Power Projects by CARE, August 2020, page 8:
Regulatory risk: Adherence to laid down Renewable Purchase Obligation (RPO) compliance norms by the states
Another major source of regulatory risk for wind power plants is adherence to the scheduling and forecasting mechanism stipulated by regulators where the power plants need to produce power in line with a forecast. For wind power plants, it is difficult to adhere to such a generation schedule because the wind speed at any location cannot be precisely predicted and cannot be controlled.
Rating Methodology for Wind Power Producers by ICRA, July 2021 page 1:
In addition, wind power producers remain exposed to regulatory challenges arising from the implementation of the forecasting and scheduling regulations, especially, given the variable and intermittent nature of the wind-based generation.
The provision of a penalty for non-adherence to the schedule complicates the matter further.
Rating Methodology for Wind Power Producers by ICRA, July 2021 page 4:
impact of the scheduling and forecasting mechanism approved by the regulators for wind power projects, wherein higher-than-permitted deviation between the actual and the forecasted generation will attract penalties.
Wind power plants face additional regulatory risk when they have to sell their power in exchange for renewable energy certificates (RECs) because the terms of sale of RECs are stipulated by regulators and any change can reduce the money that can be earned by the wind power plants via the sale of RECs.
Wind power plants selling power in the open market are also exposed to regulatory risk because such power plants need to use the distribution infrastructure (power transmission lines) of other counterparties to deliver power to their customers. The terms of such open access to the distribution infrastructure are controlled by regulators and any change in these regulations can significantly impact the wind power plant.
Rating Methodology for Wind Power Producers by ICRA, July 2021 page 6:
regulatory risks are mainly seen for the projects having PPAs under the REC route or for projects selling power under the open access route.
Summary
Wind power projects are capital-intensive projects with a large land requirement. Due to minimum spacing between wind turbines and low plant load factor, they may need up to 200 times more land to produce electricity similar to conventional fossil fuel power plants. Acquisition of land and related approvals is the most critical and risky aspect of installing a wind power plant, which has led to delays in multiple projects.
Govt. has reduced risks in wind power generation by forming large renewable power parks with a ready infrastructure of land, connectivity, power evacuation etc. Many such parks are formed in areas away from towns and villages making use of unused land.
Once constructed, wind power projects need regular maintenance. However, due to a high degree of automation and established technology, operating & maintenance costs are low and wind power plants end up earning a high operating profit margin.
Wind power production varies significantly in different seasons. The peak season around monsoons is about 3-5 months and contributes to about two-thirds of power production for the whole year. In the remaining months, the wind speed and power production are low. Therefore, proper maintenance of wind power plants is critical to ensure that they function properly in the short peak season.
Currently, the business model is a low risk due to regulatory support. Govt. promotes renewable power offtake by stipulating renewable power obligation (RPO) and the discoms mostly enter into fixed-price power purchase agreements (PPAs) for almost 25 years, which is aligned with the life of the wind power plant of about 25-30 years. Therefore, wind power plants face low market risk.
However, wind power plants, which do not have a fixed-price, long-term PPA, face market risk in the form of pricing as well as demand for their power. Moreover, at times, discoms do not adhere to renewable purchase obligations (RPO) leading to lower demand for power despite available generation capacity.
Wind power plants also face a risk of grid curtailment and lack of evacuation infrastructure, which may lead to suboptimal utilization of power generation capacity.
Creating meaningful capacities for wind power is a capital-intensive business. As a result, these plants are highly leveraged with a lot of debt, which puts a large burden on regular debt servicing cash outflows on the wind plant. Seasonal variations in wind power generation create cash flow mismatches for the plants, which have to maintain excess liquidity to meet operating, and maintenance expenses as well as debt repayments during periods of cash flow shortfall.
In recent years, the cost of wind power production has declined sharply and now, wind power has become cheaper than thermal power. However, it has simultaneously created problems for older wind power plants, which were completed previously at a higher investment. These plants have PPAs with discoms at a price, which is much higher than the current bid prices of wind power. As a result, they are facing issues of discoms attempting to renegotiate prices.
In addition, the wind power plants, which did not have long-term, fixed-price PPAs are facing severe repricing risk as the new PPAs are at a much lower price than the originally contracted prices.
Wind power plants also face issues of delayed payments as most of the customers (state discoms) are in a financially weak position. Such payment delays require wind power plants to keep excess liquidity to meet operating and debt repayment outflows, which reduces the return on their investment. Therefore, diversified wind power plant producers having plants far away from each other and dealing with many different customers are better as they face a reduced risk of natural calamities as well as delayed payments from all the customers simultaneously.
Land acquisition, offtake risk, repricing risk, and refinancing risk are some of the challenges faced by wind power plants. Additionally, wind power plants face social and regulatory risks. Regulatory risk is significant for wind power projects because any change in guidelines related to land acquisition, renewable purchase obligations, renegotiation of PPAs etc. has the potential to deteriorate the financial performance of wind power plants.
Therefore, an investor should always keep in mind these multiple aspects of wind power plants to understand the true picture of their business position.
- Large land requirements
- Low project construction and execution risk
- Capital-intensive nature of business
- Seasonality in production and high working capital needs
- Power offtake and payment risk
- Counterparty risk from long-term agreements with customers (discoms)
- Diversification benefits
- Market risk and cyclicity in absence of long-term, fixed-price PPAs
- Social and regulatory risks.
We believe that if an investor analyses any wind power plant by considering the above parameters, then she would be able to assess its business properly.
Regards,
Dr Vijay Malik
P.S.
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Disclaimer
I, Vijay Malik, am a SEBI-registered Research Analyst (Regn. No. INH100008364). This article is for educational purposes only and does not constitute investment advice or a recommendation to buy or sell any securities. Investors should do their own research before making any investment decisions.
I, or my immediate relatives, do not have any financial interest in the companies discussed as on the date of publication of this article, nor do we hold one per cent or more of the securities of such companies at the end of the month immediately preceding it. I do not have any material conflict of interest and have not received any compensation or other benefits from the companies or any third party in relation to this article during the 12 months preceding its publication. I have not served as an officer, director, or employee of the subject companies, nor have I been engaged in market making activity for them.
2 thoughts on “How to do Business Analysis of Wind Power Plants”
Dear Sir
Thank you for this wonderful article. Anything on depreciation of wind power plants and comparison of same with respect to solar, nuclear and traditional power plants?
Dear Keshav,
Thanks for writing to us!
Keshav, you may share your current thoughts about depreciation in different power plants. You may do an independent search for the answer on the internet/Google and then elaborate on your learning from such a search. We would be happy to provide our input on your line of thought on this.
Regards
Dr Vijay Malik