NZ Wind Development Plan Proposal (DRAFT)

Chinese Wind Technology A Smarter Way to Develop Large Scale Onshore Wind? A Summary Paper
By Frank MacCullaich
29 November 2011

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1.0 Executive Summary

1.1 Development Plan Proposal. This paper provides an outline of the rationale to develop commercial scale wind farms in New Zealand (NZ) using Chinese (Asian) wind technology. 90% RE by 2020. The NZ Government is committed to supplying 90% of generated electricity from renewable sources by 2020. Currently that figure stands around 70-80% subject to seasonal and yearly climatic variations. No Financial Support in NZ. There are no financial support or market tariff mechanisms to promote uptake of new energy generation technologies in NZ, which is in stark contrast to Europe, UK, USA and Australia. This is primarily due to the relatively high contribution the existing national renewable energy portfolio already generates into the domestic market, which is predominantly hydro. The Big 5 Wind Seen as High Risk Financially - The NZ electricity market share is dominated by what are known as the Big 5, consisting of the utilities (Gentailers): Contact Energy, Genesis, Meridian, Mighty River Power and TrustPower. All of these players are currently sitting on a range of wind development proposals. Internal industry information strongly indicates that few, if any, of the large (200 MW +) wind projects granted resource consent will be constructed due to the high risk of low NPV. Indications from both within the electricity industry players and Government is that geothermal is now emerging as the favoured renewable energy development technology to most significantly contribute to the 2020 RE target. Geothermal Leading New Technology. A short discussion held with the NZ Prime Minister, John Keys, in early September 2011 confirmed to the author that there are no Government plans to subsidise new energy technologies and that Geothermal is the RE technology likely to be favoured by the Government owned utilities in progressing proposals to meet the 2020 RE target. Low NPV/IRR %. It is now recognised by GenTailers that the standard financial models of large scale wind development projects in NZ do not offer scale of economies that lower the financial risk (i.e. large scale projects of 100s MW capacity are showing NPVs close to zero in worst case financial models). This is despite the NZ dollar exchange rate being currently of record-high strength (i.e. circa 2 NZD to 1 GBP at the time of writing, long term average closer to 3:1). The exchange rate is significant for capital expenditure as the standard financial model deployed by the NZ utilities look to source wind turbine supplies from Europe. Chinese Technology. In western-world markets, turbine costs make up the majority (65-70%) of the total project CAPEX. It is understood that Chinese technology is 25-40% cheaper than European suppliers. The Business Case. There is a strong investment signal for large scale wind development in New Zealand via the utilisation of Chinese wind turbine technology. The cheaper costs and equivalent quality to that of European manufacturers and robust enforcement of warranties underpins the business case of utilising Chinese suppliers, which this paper covers at a preliminary level. Due Diligence Recommendation. Appropriate further review should be undertaken to verify the business case of purchasing from Chinese suppliers such as Sinovel, including the accuracy of operational data and legal soundness of warranty enforcement in order to satisfy investment confidence requirements.

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Table of Contents
1.0 Executive Summary 2.0 Introduction 3.0 NZ Electricity Market Background 4.0 Financial Model NZ Onshore Wind Farm 2 4 4 5

Wholesale Market Structure .......................................................................................................................................... 4

Figure 1 - European TSA .............................................................................................................................................. 6 Figure 2 - Chinese TSA ................................................................................................................................................. 7 Figure 3 - TSA Comparative Costs ................................................................................................................................ 8

5.0 Warranties Issue of Security 6.0 Summary & Recommendations

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2.0 Introduction
2.1 The overall aim of this summary paper is to provide an indication of the signals to invest in the NZ onshore wind market using Chinese (Asian) commercial scale onshore wind technology. There is a case study on comparing the costs of a top Chinese wind turbine supplier to that of the leading European manufacturers. In addition, there is a preliminary review of the warranties for operational availability and power curve performance that the case study Chinese supplier could offer. The report begins with an overview of the present NZ electricity market regulatory structure and subsequently presents a financial model of a 62 MW onshore wind farm, comparing the financials of wind turbines supplied from Europe to that of China. The information supplying the comparative financial models was sourced from an actual project (62 MW) based in Scotland. The report does not detail the merits of New Zealands wind regime, planning system or the nuances involved in obtaining a Power Purchase Agreement (PPA), as this would be subject to a more detailed and broader scope study on the investment signals of the NZ wind market. Nonetheless, it is suffice for the purposes of this report to add that resource (planning) consent applications for commercial scale onshore in New Zealand have a greater than 90% approval rate and that it is one of the windiest countries in the world with many potential development sites enjoying 10m/s average wind speed and over 40% capacity factor .

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3.0 NZ Electricity Market Background

Wholesale Market Structure
3.1 The New Zealand wholesale spot market is based on bid-based security-constrained, economic dispatch with nodal (location) prices. Electricity is traded at a wholesale level in a spot market. The market operation is managed by several service providers under agreements with the Electricity Authority (NZ). The physical operation of the market is managed by Transpower in its role as System Operator. Generators submit offers through a Wholesale Information and Trading System (WITS). Each offer covers a future half-hour period (called a trading period) and is an offer to generate a specified quantity at that time in return for a nominated price. The System Operator (Transpower) uses a scheduling, pricing and dispatch (SPD) system to rank offers, submitted through WITS, in order of price, and selects the lowest-cost combination of resources to satisfy demand. Electricity spot prices can vary significantly across trading periods, reflecting factors such as changing demand (e.g. lower prices in summer when demand is subdued) and supply (e.g. higher prices when hydro lakes and inflows are below average). Spot prices can also vary significantly across locations, reflecting electrical losses and constraints on the transmission system (e.g. higher prices in locations further from generating stations). Trades take place at approximately 285 nodes (grid injection points and grid exit points) across New Zealand every half-hour. Generators make offers to supply electricity at 59 grid injection points (GIPs) at power stations, while retailers and major users make bids to buy electricity at 226 grid exit points (GXPs) on the national grid. Final prices at each node, taking account of grid losses and constraints, are processed and confirmed the following day.

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NZ Wind Development Plan Proposal (DRAFT) 3.5 All electricity generated is required to be traded through the central pool, with the exception of small generating stations of less than 10MW. Bilateral and other hedge arrangements (PPA) are possible, and function as separate financial contracts. Industry knowledge indicates that Power Purchase Agreements (PPA) obtained today would be circa $80 per MWh, for a typical period of 5 years.

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4.0 Financial Model NZ Onshore Wind Farm

4.1 The simple financial models constructed have relied on experience of the author and in-house data from established UK and NZ wind developers. The investment model is developing an onshore wind farm on a Greenfield site through resource consent, construction to operation. Both investment scenarios, Figures 1 and 2, are modelled on an actual onshore wind farm, (i.e. capacity, capex, opex, wind resource, operational life span), containing the following assumptions: Operational life of 25 years (now industry standard); No financial support; Project start year 2015. Installed name plate capacity of 61.7 MW; Average wind speed of 8 m/s; Annual average wind resource (net output) of 218.7 GWh amounting to 40% Capacity Factor. Yield prediction of 3.54 GWh/yr per MW installed, as provided by Siemens; Grid Use of System charges based on $40 per installed kW per annum; Revenue (PPA) begins at $90 per MWh come year 2015, based on 2.5% inflation rate from 2011; An annual inflation rate of 2.5% (applied to revenue as well) and discount rate of 10%; and Exchange rate of 2 NZD per every GBP sterling.

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Figure 1 is modelled on a contracted Siemens Turbine Supply Agreement (TSA) price. Figure 2 is modelled on a received Sinovel Tender Price Band (representative Chinese TSA price). Yield prediction was 13.5% more than Siemens at 4.09 GWh/yr per MW installed; however, both the financial models use the Siemens yield figure as the benchmark. Sinovel is close to 36% cheaper than Siemens, which is the only variance used in the financial model comparative. The full spreadsheet versions of the financial models are provided seperate to this report, and shown in summary below.

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Figure 1 - European TSA

4.8 Figure 1 (Siemens) shows a negative NPV with PPA of $90/MWh flat (annual 2.5% inflation) at 10% discount rate from Start Year 2015. Profit is possible in the following scenarios: PPA of $95/MWh, with 10% Discount Rate, produces an NPV of $9.3 Million; PPA of $90/MWh, 6% Discount rate produces an NPV of $59.3 Million; and PPA of $95/MWh, with 6% Discount Rate, produces an NPV of $73.8 Million.

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Figure 1. NZ Windfarm Financial Model European TSA.

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Based on the above worst case model scenario and the current strong NZD exchange rate being likely short-term, it is easy to appreciate the high investment risk and the reason, therefore, that NZ GenTailers are nervous to advance resource consented projects in the multiple 100s MW capacity range.

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Figure 2 - Chinese TSA

4.11 Figure 2 (Sinovel) shows a significantly positive NPV of $53.1 Million with PPA of $90/MWh flat (2.5% inflation) at 10% discount rate from Start Year 2015. Profit is enhanced in the following scenarios: PPA of $95/MWh, with 10% Discount Rate, produces an NPV of $63.1 Million; PPA of $90/MWh, 6% Discount Rate produces an NPV of $115.2 Million; PPA of $95/MWh, with 6% Discount Rate, produces an NPV of $129.7 Million.

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Figure 3 - TSA Comparative Costs

4.13 Figure 3 shows a snapshot TSA prices collected from a phase 1 tender process undertaken for a UK onshore wind farm in late 2010. Prices shown are in Euros and includes full contract price of: Turbine Supply & Installation, Transformer (Switch gear & installation) and full transportation from source to site.

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Figure 3. Wind Turbine Supply Agreement Costs () A Comparison (2010). 4.15 From the above Figures 1-3 it is clear that Chinese suppliers, such as Sinovel, could enable a strong business case based on financial terms to develop onshore wind farms in New Zealand.

5.0 Warranties Issue of Security

5.2 With China being a communist state, it is natural for developers from capitalist nations to raise questions regarding the risk involved in the security strength of warranties for power curve performance and generation availability. Warranty security underpins the business case for Asian technology just as much as the capital turbine cost being an average 26% cheaper (see Fig. 3) than European suppliers.

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Sinovel Preliminary Due Diligence Case Study 5.4 From discussions held with the author to date, Sinovel offered the following information in regards to existing operational records, warranty of performance and availability: Operational Availability Guarantee. Sinovel is able to provide an availability guarantee of 97%. Warranty Period Provide 10 years warranty period, first 2 years free. During the warranty period the operational availability, noise levels, and power curve performance are all guaranteed. A liquid damage would apply if any aspect fails the contractual level; Financial Bond. Held by independent legal third party to pay the liquid damage in the event that Sinovel does not comply with warranty conditions and/or compensation for loss of opportunity costs (downtime);

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Detailed Due Diligence. Sinovel are willing to assist any detailed analytical process of recorded site data, engineering analysis and contract legal review, including a site visit to China to look at existing wind farms and manufacturing plant; Operational Records. Due diligence parties will obtain access to data and operational plant to assess performance and maintenance records obtained from existing wind farms operating in China. The 5 year operational site records for both the 1.5MW and 3MW models are available for inspection and will show 94-98% availability; Bank Finance. Sinovel as supplier would be able to access Chinese bank finance for constructing consented projects; and Miscellaneous. Sinovel are willing to consider any proposals to enable a breakthrough into the western market.

6.0 Summary & Recommendations

5.5 Chinese onshore commercial scale wind technology is 25-40% cheaper than European suppliers, which creates potential development opportunity for those markets not containing any financial subsidies to promote the uptake of renewable energy technologies, such as New Zealand. Furthermore, other western markets could realise potential for lowering capex and thereby increasing net profits (e.g. Canada, Europe, UK, USA). As a communist state there are obvious questions to ask of Chinese (Asian) suppliers regarding the risk involved in the security of warranties for power curve performance and generation availability. Detailed due diligence involving Chinese turbine suppliers, such as Sinovel, should be carried out to verify the accuracy of operational data and legal soundness of warranty enforcement in order to satisfy investment confidence issues. It is recommended that wind industry parties look for cooperation to further investigate the preliminary business case presented in this paper, a process in which the author (FMAC Ltd) is willing to be part of.

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For more information contact the author:

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Kind Regards, Frank MacCullaich BSc PgD MEnvS FMAC@FMAC.co.nz Direct: +64 (9) 536 4103 Mob: +64 21 956 989
Auckland New Zealand

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