DRAFT – FOR DISCUSSION PURPOSES
Attractive Price Discovery? Or the Discovery of Attractively-Priced Debt with
High Capacity Projects?
Assessing $57/MWh Wind Power in Brazil’s Recent Energy Auctions
The appropriate lesson appears to be that high capacity wind power can compete effectively with
conventional generation sources – provided that it has stable access to debt financing on terms that are
favorable (or, at least, not as punitive as a ~15% annual coupon). This suggests, in coordination with outlays
from a “green” development bank, large-scale auctions may be well-suited to promote more mature
renewable technologies such as wind power (particularly in markets that have developers with established
track records). Setting standards for realistic bidders is a key element in any successful auctioning process.
Summary
In August and December of 2011 Brazil held auctions to procure long-term energy contracts from a combined 5.1 GW
of new electric generation capacity. Wind power developers dominated these auctions, with projects representing
2.88 GW of new capacity bidding successfully to supply energy to Brazil’s grid; moreover, average bidding prices
resulting from these auctions were strikingly low – from $62/MWh (in the August 2011 auction) to $57/MWh (in the
December 2011 auction). If constructed, these wind power projects will more than triple Brazil’s installed wind power
generating capacity at a $/MWh cost 62-64% below what Brazil had been paying new wind power projects under its
feed-in-tariff PROINFA program.
The success of wind power bids in Brazil’s latest auctions is increasing interest in auction mechanisms (or “tenders”)
as a means to promote investment in low-carbon generation technologies. Proponents explain $57/MWh contract
prices for wind as a result of the competition and price discovery that auction mechanisms purportedly create; further,
they cite such prices as evidence that auctions can encourage deployment of low-carbon technologies more costeffectively than a price-based instruments such as a feed-in-tariffs (FiT). Historically, however, in some markets
auctions have been “bid” but then not necessarily “built” as bidders find when it comes to execution they cannot
deliver at the agreed-upon price.
The low prices bid by wind developers in Brazil’s recent regulated auctions have implications for both the costeffectiveness of capacity auctions as a policy mechanism and the economic competitiveness of wind generation
relative to other resources. It therefore becomes critical to determine how the Brazilian bidders managed to get to
$62-$57/MWh. Importantly market analysis has shown the importance of wind capacity factors. Specifically, our
analysis further highlights the role of loans from Banco Nacional de Desenvolvimento Economico e Social (“BNDES”)
- Brazil’s state-owned development bank – in reducing financing costs for participants in Brazil’s energy auctions. We
find that replacing BNDES loans with commercial debt increases the levelized cost of energy (LCOE) of a typical
Brazilian wind project by 23%. Indeed the low bid cap that Brazil’s energy regulator has set for its next energy
auction in March 2012 – $65/MWh, $15/MWh below what we calculate as the unsubsidized LCOE of a favorably-sited
wind power project in Brazil based on commercial loans – underscores the strong influence of BNDES debt on the
contract prices in Brazil’s energy auctions.
Improving financing terms for developers of low-carbon generation is a legitimate and valuable focus of government
policy. Many other countries have “green development banks” such as KfW, the EIB and potentially the UK Green
bank and Australian CEFC. The role of BNDES loans in driving the success of wind projects in Brazil’s energy
auctions, however, yields the following conclusions: 1) unsubsidized “grid parity” for wind generation remains in most
markets a work in progress and certainly requires bery high capacity factors; and 2) low-cost debt can effectively
stimulate wind developers to bid into auctions at attractive prices – but still does not necessarily ensure that the
equity returns on such projects will be sufficient for developers to carry the projects to fruition.
1
DRAFT – FOR DISCUSSION PURPOSES
Indeed, as a study by BNEF last August showed, the equity return on a project bid into the auction are such that there
is still considerable risk that some are not built.
History of Brazil’s Energy and Capacity Auctions
On the theory that short-term market signals provided insufficient incentives to invest in new generation capacity, in
2004 Brazil’s energy regulator - the Agencia Nacional de Energia Electrica (ANEEL) – began holding auctions to
procure long-term energy contracts. These “reverse auctions” essentially follow a three-step process:
1.
2.
3.
To start the process, the regulator establishes a $/MWh ceiling energy price for all projects
irrespective of technology. Projects are asked to pre-register their initial $/MWh bids and the
ceiling price is used to filter out technologies whose bids are uncompetitive. This initial phase is
used to facilitate price discovery by the regulator.
Remaining projects progressively bid down the price, as the amount of energy contracted for rises
to meet the regulator’s target amount.
In the final phase, the regulator satisfies the target energy demand by awarding bids to the
cheapest contracts; the format is “pay-as-bid,” meaning that successfully bid projects receive the
$/MWh price that they have bid (rather than all projects receiving a uniform clearing price).
While the fixed-price contracts resulting from these auctions vary in length, the contracts of interest to this paper are
20-year power purchase agreements (PPAs). Projects are expected to begin generating electricity either three or five
years from execution of the auction contract.1
To discourage submission of unrealistically low bids, Brazil levies penalties for non-compliance ranging from 0.001%
to 10% of the announced investment in each project. Brazilian regulators have, however, traditionally been
disinclined to impose such penalties; this creates risk that contracted projects will not actually be constructed – a
topic discussed in detail below. Setting standards for realistic bidders is a key element in any successful auctioning
process.
Wind Power Enters (and Begins to Dominate) Brazil’s Auctions
In response to a projected decrease in the share of renewable electricity in total generation, in December 2009
ANEEL held its first-ever wind-only auction. The initial auction awarded 20-year, fixed-price PPA contracts for 71
different wind energy projects (with a combined capacity of 1,800 MW) at an average price of $89/MWh. In August
2010 wind power projects moved from a “wind only” auction to a “clean energy only” auction in which wind projects
competed with small hydro and biomass units; the auction resulted in the award of contracts for 1,519 MW of wind
power (representing 50 projects) at an average price of $78/MWh. Developers with the most contracted capacity
were Impsa-Energimp and Iberdrola.
In August 2011, clean energy generation projects (including wind power) for the first time competed directly with nonrenewable (such as natural gas-fired units) and large hydro projects in government auctions.2 Wind power emerged
as the major winner in these auctions, claiming over half of new contracted capacity (2.88 GW) at an average price of
$62/MWh. The August 2011 auction represented the first time that Brazilian wind projects had under-bid natural gasfired projects (two of whom secured contracts for $65/MWh).
Wind power projects continued to “run the table” during Brazil’s most recent auction in December 2011. Of 1.2 GW of
capacity qualified for bidding – a mix of wind power, large-scale hydropower and biomass - wind projects won 81%
(976 MW) of total contracted capacity at an average price of $57/MWh – nearly 40% below the average price in the
August 2009 “wind only” auction. Projects slated for the northeast of Brazil in the states of Bahia, Ceara and Rio
Technically, Brazil holds two kinds of energy auctions: one for primary energy (termed “energy” auctions), and one for energy from reserve capacity
(termed “capacity” auctions). This analysis considers the two kinds of auctions jointly.
2
One for primary energy and one for reserve energy.
1
2
DRAFT – FOR DISCUSSION PURPOSES
Grande do Norte will account for the majority of the 976 MW of wind capacity awarded. Collective investment in the
wind projects in these areas according to Bloomberg New Energy Finance is estimated to approximate BRL 3 billion
(USD$ 1.6 billion). Moreover, in Brazil’s next energy auction (in March 2012, with a ceiling price of $65/MWh), wind
is expected to again claim the lion’s share of new contracts.
Figure 1 Total capacity and number of registered versus contracted projects participating in the A-5
energy auction, 20 December 2011 (MW)
Source: Bloomberg New Energy Finance, Empresa de Pesquisa Enérgetica (EPE)
Table 1: Brazil A-5 auction average contract price by technology, 20 December 2011 ($/MWh)
Average contract price ($/MWh)
Contracted
(MW)
Large Hydro
$49.47
135
Biomass
$53.76
100
Wind
$56.90
976.5
Capacity
Source: Bloomberg New Energy Finance; Câmara de Comercializacão de Energia Elétrica (CCEE
Will Bid = Built? Problem of Potentially Inadequate Equity Returns
Even given Brazil’s terrific wind resource, the August and December 2011 average contract prices for wind
generation of $57-62/MWh are strikingly low. They represent a 30% reduction from the average contract price of
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DRAFT – FOR DISCUSSION PURPOSES
$87.6/MWh that wind developers secured in Brazil’s A-3 2009 auction.3 Moreover, these prices are below the
$70/MWh level that (1) analysts estimate as a mid-range scenario for the levelized cost of energy (LCOE) from wind
generation in Brazil; and (2) is thought to have been the “minimum bid price” contained in contracts between Brazilian
wind developers and their original equipment manufacturers (OEMs). 4 Some developers may be able to renegotiate
their supply contracts so that their OEMs accept lower margins; others may succeed in achieving unprecedented
capacity factors (e.g. 55-60%) via use of such novel tactics as placing high-efficiency turbines (designed for sites with
low wind speeds) at sites with high wind speeds. Uncertainty about such outcomes, however, gives rise to strong
prima facie suspicion about what kind of equity returns $57-62/MWh contracts will yield for project developers.
Analysis from Bloomberg New Energy Finance (BNEF) confirms this suspicion. Firstly a cost of debt of 8.75% is
used, which relies on BNDES loans – see discussion in the next section. Evaluating the 78 wind projects contracted
in Brazil’s August 2011 A-3 and capacity auctions BNEF calculates that 32 of these projects – representing 870 MW
of new capacity (40% of total capacity tendered) – will deliver an annual return to equity of less than 10%.5 Annual
equity returns on many of these projects appear to be below 7.5%. Even taking into account the burden of Brazil’s
non-compliance penalties, returns of this magnitude may provide inadequate incentive for developers to actually
construct their projects – hence recreating the specter of “bid but not built” projects that has played out in the wake of
capacity auctions in the UK and elsewhere. Anecdotal evidence for the unattractive economics of investment in wind
generation at Brazil’s recent regulated tariffs can be found in the announcement of Desenvix Energias Renovaveis
SA – Brazil’s leading renewable energy developer – that it will forego bidding wind projects into Brazil’s March 2012
auction because “the returns are far too low for us.”6
Figure 2 Estimated equity returns of the winning wind bids in the A-3 and capacity auction versus
capacity factors for these bids, 2011 (%)
20%
A-3
Reserve
15%
10%
High
deployment risk
5%
0%
30%
35%
40%
45%
50%
55%
60%
Capacity factor
-5%
Note: Assumes CAPEX costs of nearly $1.9m/MW, fixed OPEX costs of $50,000 per year as well as a $3-$6/MWh
hedge structure, 70:30 gearing ratio and a 8.75% cost of debt. Annual inflation fixed at 5% for 20 years.
Source: Bloomberg New Energy Finance, 2011.
3
By contrast, from 2009-2011 global wind turbine prices declined by only XX%.
See BNEF…
Yielding an annual equity return above 10% seems to require a project to have an annual capacity factor of at least 45%; by comparison, for onshore
wind in the US, the Energy Information Administration assumes an average annual capacity factor of 34%.
6
“Brazil Desenvix Shifts from Wind to Hydro as Power Prices Fall”, Bloomberg New Energy Finance, 15 Feb 2012, https://www.bnef.com/News/53016.
Renova cited a price of $76/MWh as the floor beneath which returns on wind development became uncompetitive.
4
5
4
DRAFT – FOR DISCUSSION PURPOSES
BNDES debt – the 600 bps subsidy embedded in every wind power bid
Recognizing how low prices seem to imperil equity returns on a large portion of the wind projects that Brazil has
recently contracted under its regulated auctions, there remains one further element of project economics worth
emphasizing: the extent to which these prices reflect below-market debt financing provided by BNDES. As a stateowned lender, BNDES is able to provide low-interest loans (“soft dollar” loans) in order to stimulate growth of target
industries such as alternative energy. Since 2000 BNDES has committed roughly $10 billion of loans to support
development of Brazil’s wind resource (Figure 2); based on data provided by BNDES, we calculate another USD$4.6
billion to be committed through 2013. BNDES loans to Brazilian wind developers appear to carry interest rates 500750 basis points (bps) below prevailing commercial rates. Based on current commercial rates for Brazilian wind
developers (14% - 15% per annum), BNDES debt reduces borrowing costs for eligible wind projects by roughly 40%.
Nearly every wind project that has bid into any of Brazil’s auctions has done so with the benefit of debt from BNDES.7
Amount Financed, USD billions
Figure 2 – BNDES Wind Power Asset Financing In Brazil
6,000
5,000
4,000
3,000
2,000
1,000
0
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
BNDES New Project Financing (Completed and Committed)
Source: Bloomberg New Energy Finance, 2012 and DBCCA analysis, 2012
BNDES Debt as a Driver of low PPA Prices for Wind Power
The analysis below seeks to quantify the impact of BNDES “soft loans” in lowering average contract prices for wind
power in Brazil’s regulated auctions. To do this, a “base case” LCOE – taking into account the benefit of BNDES
debt - is calculated for a generic Brazilian wind power project bid into the August and December 2011 regulated
auctions.8 The LCOE represents the present value of a project’s lifecycle costs (construction, financing, operating,
fuel, decommissioning) divided by the present value of its lifetime generation; since the resulting $/MWh cost includes
the costs of equity and debt, it can be thought of as the PPA price required for a project to deliver a given level of
return to its investors. Base case assumptions are then modified to reflect the impact of debt financing on
7
Developers of other low-carbon technologies (e.g. biomass and small hydro) can access BNDES financing on terms similar to those available for wind
projects; hence BNDES financing is similarly ubiquitous in the bids from developers of these technologies participating in Brazil’s regulated auctions.
BNDES low-cost debt is generally not available, however, to developers of more mature technologies such as natural gas-fired turbines or large hydro
facilities.
8
Note that (1) the LCOE of a wind project is highly sensitive to the quality of its wind resource, as measured by its site’s “capacity factor”8; and (2)
variance in capacity factors across different sites can lead to a wide range of LCOE values for wind projects (whether in Brazil or elsewhere). That
said, calculating the economics of a “typical” project can still illuminate the major influences on the competitiveness of wind generation.
5
DRAFT – FOR DISCUSSION PURPOSES
commercial terms (i.e. approximately a 600 bps premium relative to BNDES rates). We find that use of market-rate
debt increases the LCOE of a Brazilian wind project by 23%.
Table 2 illustrates the LCOE for “base case” Brazilian wind power project bidding into Brazil’s energy auctions.
Similar to the large cluster of projects depicted in the middle of Figure 2 above, the project is assumed to have an
annual capacity factor of 50% and an annual return to equity investors of 12% in nominal terms (7.5% year in real
terms, assuming 4.5% annual inflation). Reflecting the uniformity of BNDES debt among such projects, the project is
assumed to receive 16-year debt at an interest rate of 8.75%. As displayed in the highlighted row, terrific capacity
factor and favorable financing makes this project - at ~$65/MWh - among the most competitive for wind power
projects in any region of the world.9
Table 2 – Base Case LCOE for a Brazilian Wind Project (including BNDES debt)
Capital & Financing - Construction
Insurance
Ad Valorem Costs
Fixed O&M
Corporate Taxes (w/Credits)
Fixed Costs
Fuel & GHG Emissions Costs
Variable O&M
Variable Costs
Transmission Service Costs
$/MWh
$56.48
$0.79
$0.00
$6.18
$1.96
$65.42
$0.00
$0.00
$0.00
$0.00
Total Levelized Costs
$65.42
Financial Information
Cap Structure
Equity
Debt Financed:
30.0%
70.0%
Discount Rate (WACC)
Loan/Debt Term (Years)
Equipment Life (Years):
9.73%
16
30
Capacity Factor
Cost of Capital
12.00%
8.75%
50%
Note: Assumes annual inflation of 4.5% and taxes equal to 3% of annual gross revenues.
Source: California Energy Commission Levelized Cost of Energy model, 2010 and DBCCA analysis, 2012
Comparing the $65/MWh LCOE calculated above – for a project with a 50% annual capacity factor - with Brazil’s
actual average contract prices of $57-62/MWh reaffirms the point depicted in Figure 2 above: that prices this low
require very high capacity factors and, for projects with capacity factors below ~45%, annual nominal returns to equity
at or below 10%.10 Comparing Table 2 with Table 3, however, illustrates a second key point: that prices observed in
Brazil’s recent regulated auctions depend critically on BNDES “soft loans” provided at below-market rates. Raising
the cost of debt for a Brazilian wind project to commercial terms increases project LCOE by 23%.11
9
For comparison, assuming a real after-tax weighted average cost of capital of 7.4%, the US Energy Information Administration calculates an LCOE
range for US onshore wind of $82-$115/MWh.
10
If the annual capacity factor of the base-case project is lowered to 45%, then maintaining an LCOE of $65/MWh requires the annual nominal return to
equity to come down to 8.5%.
11
To the extent that absence of BNDES lending removes the perception of implicit state protection against project failure, a switch to commercial debt
may also increase a project’s equity risk premium; the resulting increase in WACC will raise project LCOE above the 23% calculated here.
6
DRAFT – FOR DISCUSSION PURPOSES
Table 3 – LCOE of a Brazilian Wind Project with Market-Rate Debt
Capital & Financing - Construction
Insurance
Ad Valorem Costs
Fixed O&M
Corporate Taxes (w/Credits)
Fixed Costs
Fuel & GHG Emissions Costs
Variable O&M
Variable Costs
Transmission Service Costs
$/MWh
$71.67
$0.73
$0.00
$5.50
$2.41
$80.30
$0.00
$0.00
$0.00
$0.00
Total Levelized Costs
$80.30
Cap Structure Cost of Capital
Financial Information
12.00%
14.75%
30.0%
70.0%
Equity
Debt Financed:
13.93%
16
30
Discount Rate (WACC)
Loan/Debt Term (Years)
Equipment Life (Years):
50%
Capacity Factor
Note: Assumes annual inflation of 4.5% and taxes equal to 3% of annual gross revenues.
Source: California Energy Commission Levelized Cost of Energy model, 2010 and DBCCA analysis, 201
Given the capital-intensity of wind projects, the magnitude of this shift is unsurprising. The resulting LCOE of
$75/MWh is higher than any of the prices recorded in Brazil’s August or December 2011 auctions (which was
$65/MWh price for energy from two combined-cycle natural gas units recorded in August 2011); it is also above the
$65/MWh price ceiling that Brazil’s energy regulator has set for Brazil’s forthcoming auction in March 2012. This
suggests that – even with excellent capacity factors – market-rate debt would price Brazilian wind out of the very
auctions that is has so thoroughly dominated over the past year.
Implications of Pervasive BNDES Lending in Brazil’s Regulated Auctions
Compared with financing available to wind project developers in the US and Europe, loans that carry an 8.75%
annual coupon are hardly “cheap debt.” That said, in the case of Brazil, such loans are very much “below-market”
debt. Recognizing this has implications for how one interprets the low contract prices for wind recorded in Brazil’s
recent regulated auctions. This note affirms the judgment of BNEF that such low prices may indicate modest equity
returns for many developers who have bid into such auctions – and thus presage a wave of project defaults (similar to
circumstances following regulated capacity auctions in other countries). Moreover, this note finds low contract prices
for wind to reflect in large measure the ~600 bps savings in annual debt costs enabled by BNDES loans to wind
developers.12 Had wind developers been forced to bid into Brazil’s recent regulated auctions using commercial debt
finance, it is likely that they would have won contracts for a far smaller volume of energy – and at prices well above
$57-62/MWh. It also encourages developers to seek the very highest debt ratios they can.
12 It bears repeating that such BNDES also extends such low-cost financing to other alternative technologies such as biomass and small hydro.
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DRAFT – FOR DISCUSSION PURPOSES
This latter conclusion relates to lessons one draws from Brazil’s recent auctions for (1) the cost-effectiveness of
auction mechanisms as a means to promote deployment of renewable resources; and (2) the cost-competitiveness of
wind generation relative to other generation sources. The appropriate lesson appears to be that high capacity wind
power can compete effectively with conventional generation sources – provided that it has stable access to debt
financing on terms that are favorable (or, at least, not as punitive as a ~15% annual coupon). This suggests, in
coordination with outlays from a “green” development bank, large-scale auctions may be well-suited to promote more
mature renewable technologies such as wind power (particularly in markets that have developers with established
track records). Setting standards for realistic bidders is a key element in any successful auctioning process.
8