by Seth Beck and David Haarmeyer
Boston, United States [Renewable Energy World Magazine]
The global financial turmoil and economic slowdown will help the wind industry in three important ways. First it will stabilize costs, secondly, it will strengthen the supply chain, and thirdly, it will lead to a more mature construction and ownership model, consistent with sustainable growth. Seth Beck and David Haarmeyer explain how.
Last year, many analysts were predicting annual wind installations to grow by 15%–20% over the next decade. The dramatic collapse of the world’s credit markets has prompted a revisiting of forecasts and a dialling back of expectations. Recent years of record growth in the US and global wind industry had been expected to be sustained primarily because of wind’s improving economics and its low penetration rate. Global wind installations rose at a 27% combined annual growth rate (CAGR) from 2000–2007, resulting in an installed capacity of some 94 GW. With a record growth year in 2007, which totalled 19 GW and to which the US contributed 26.4%, it appeared as if the industry was poised to continue this trajectory well into the future. Still, representing only 1% of world electricity generation, wind has enormous opportunities for growth.
The factors driving wind’s growth remain robust. First and foremost, continuous improvement in technology has enabled dramatic reductions in the cost of wind power. A second major growth driver has been government support in the form of production tax credits, subsidies in the US, carbon legislation in Europe, portfolio standards in Canadian provinces and American states, and the government mandates and policy directions seen in Asia. In addition, wind’s comparative cost with fossil-fuelled generation has also benefited from the steady tightening of government-mandated environmental controls on fossil generation. Together, these have made wind an increasingly competitive technology.
As of September 2008, US installed wind power capacity stood at 21 GW, with a further 7.5 GW under construction. Wind has been given a particularly big boost by the growing use of aggressive Renewable Portfolio Standards (RPS) by state governments. This legislation has essentially set the floor for renewable growth. The ceiling for growth in the industry is dependent upon many variables. The most important limiting factor is likely to be the industry’s production capacity and resilience to grow on a sustainable basis, although a strong cap-and-trade programme or a 25% federal RPS could fuel aggressive growth.
Wind generation has also encountered a number of significant challenges, hindering its ability to expand. After experiencing a steady reduction in costs in the 1980s and 1990s, wind turbine prices have increased by more than $600/kW since 2001. Consequently, the rising cost structure harms the industry’s competitiveness with other forms of generation. The industry’s nascent supply chain has also struggled to keep up with increasing demand, and as a result, lead times have grown and quality suffered. At the same time, the industry’s rapid global growth has encouraged the market entry of numerous developers and manufacturers with multiple competing business models.
In large measure these challenges are the natural growing pains of an emerging global business. Ultimately, today’s economic downturn and financial turmoil will accelerate the industry’s steps toward becoming more competitive, productive, and capable of delivering long-term sustainable growth.
Turbine price stabilization
Leading up to the collapse of the credit markets, wind projects experienced a steady increase in cost per kW. This increase was fed by intense global competition for commodities and equipment, especially from rapidly growing emerging market nations such as China and India.
Over the past few years, strong demand and the fear of turbine shortages fuelled a speculative buying environment, resulting in a seller’s market. PowerAdvocate’s Wind Turbine Index shows that from 2000 to the 3rd Quarter of 2008, costs increased 112%, see Figure 1, above. The underlying drivers behind this dramatic rise were demand for components and rising prices of commodities that made up those components, as shown in Figure 2, below.
The global financial downturn has abruptly and radically changed the economic landscape of the wind industry. In the face of shaky financial institutions, plunging commodities, and market uncertainty, utilities and developers, as with the entire energy business, are cutting or delaying capital projects, including wind farms.
Tightening credit markets have made financing prohibitively expensive, if available at all for many developers. Moreover, the financial crisis has removed a few key players in the wind industry. For example, Lehman Brothers, one of five top wind-power lenders on Wall Street, went under; Wachovia and AIG have been sold and sidelined, respectively; and JP Morgan and GE Energy Financial have been weakened. The bottom line is that with financing having dried up and lower economic growth, the demand for turbines by utilities and developers has fallen significantly.
The evidence of a market in retreat is stark, and includes announcements and reports in the press:
- General Electric Co. may delay delivery of new wind turbines as some customers scrounge for finance
- Suzlon Energy Ltd. announcement that the global credit crisis has slowed orders for turbines
- Gamesa Corp. Technologies SA suspended production for an extra week over the Christmas 2008 holiday at two of its sites
- Vestas Wind Systems A/S to suspend hiring of new workers because it expects 2009 production to be 15% below its workforce capacity
- BP’s decision to end planned wind power projects in India, China, and Turkey and focus on onshore plants in US
- FPL Group Inc. cutting capital spending for wind-energy projects by nearly $1 billion in 2009, reducing the capacity of the planned projects by 27%
- BP Capital, Boone Pickens’ company, which ordered nearly 670 wind turbines, curtailing its effort to acquire a state permit to build the 170 miles (272 km) of transmission lines required.
As Figure 3 above shows, the credit meltdown helped to put an end to the commodity bull market of the last seven years. Over the last three months of 2008, commodity prices declined by over 30%. This dramatic fall presents a tremendous buying opportunity for buyers of wind turbines before the economy and demand for materials and equipment bounce back. While the global economic crisis has weakened the electric power industry’s short-term growth levers, the basic need to upgrade existing and build new infrastructure to meet future electricity demand means that the underlying fundamentals remain solid. This is especially true for developing countries such as China, with a projected electric load growth of almost 40% by 2020 to just over 3000 TWh.
How far have wind turbine costs fallen, and how far will they fall? Applying a ‘should-cost assessment’ to wind turbines provides a method to quantify the impact of falling commodity prices and demand changes. This method involves determining the commodity make up of a wind turbine and then quantifies how commodity price declines, as well as changes in demand, should impact the cost of a turbine.
In addition, utilities and developers of wind farms should also benefit from the impact of falling commodity prices on transmission equipment too. PowerAdvocate analysis indicates that, armed with market intelligence, buyers could negotiate prices for wind turbines that are 10%–18% cheaper than they were at market high in Q3 of 2008.
Thus, an important silver lining in today’s economic downturn has been the slowing demand growth and reduction of commodity costs. These changes will stabilize the costs of building wind farms and bring economic certainty into the business. The change in economic fundamentals has also transformed the business from a sellers’ to a buyers’ market, which will ensure wind manufacturers and developers are more aligned with customer demand.
Strengthening the supply chain
The rapid growth of the wind sector created serious challenges for the industry’s supply chain in ensuring that quality components, materials, and services were delivered on time by qualified suppliers. Long lead times of two years or more were a symptom of both a seller’s market and shortcomings within the supply chain.
The supply chain of the wind business is complex and exposed to a number of risks. Rapid growth accentuated these risks as new suppliers for the 8000+ different components found in a typical turbine entered the business. Simultaneously, the distances between manufacturing plant and final market grew. Thus, the downside of rapid global growth from a small supply base is that it created higher transport and logistics costs, increasing quality problems, and longer lead times.
Until the economic downturn, the main pinch points in the supply chain were gearboxes, large bearings, and turbine blades, which rely on capital-intensive production facilities that take a significant amount of time to set up. In addition, the materials involve steel, cast iron, bearings and other inputs that are in demand by other component manufacturers across all heavy industries. The shift to multi-megawatt machines with larger components placed added strain on an already tight supply chain.
In its August 2008 report, BTM Consult predicted that ‘over the next two years, the major component constraint is forecasted to be on account of larger bearings for gearboxes and main shafts and blade pitching bearings, casting and forging capacity,’ and that the supply chain would balance out with demand by 2012.
One of the more critical steps of a wind project is co-ordinating logistics to meet tight schedules. A 100 MW project, for example, is likely to have more than 650 heavy hauls that need to arrive in a precise sequence. Due to the current composition of the supply chain, these shipments originate from different factories often located in vastly different geographic locations. To minimize potential logistics issues, the industry is moving new production facilities closer to future installations. This has been a significant challenge due to the sudden emergence of new markets in North America and Asia, coupled with the high demand of existing markets in Europe.
Another serious problem related to the wind industry’s constrained supply chain is quality. Quality issues have been prevalent in gearboxes and blades. Many of these issues can be attributed to not having adequate testing time for the newer larger turbines. Due to the high demand for larger turbines with higher outputs in low speed wind regions, manufacturers are under pressure to rapidly push turbines into commercial operation. In addition to some design flaws, high volume in production facilities have led to quality issues within the manufacturing process and put more pressure on buyer supply chain organizations.
But, with demand for turbines falling, manufacturers will have more time to improve supply channels, unclog bottlenecks, and reduce lead times for critical components. New manufacturing facilities are also under construction or planned in the fastest growing markets, including China and the US Midwest. These developments will put the supply chain in a stronger position to meet demand than it would have been prior to the economic downturn.
As the wind industry matures, major players increasingly recognize that the supply chain is critical to their business as it is both a cost and profit centre. Issues of quality can have major impacts on a firm’s brand and hence perception by both shareholders and the general public. As the industry matures, commitment to service and reliability will be instrumental to building successful global brands.
Consolidation of business, ownership and development models
An overlooked and under appreciated value of financial downturns is that they play an important economic role, especially when they come after frothy and unsustainable growth spurts. As markets expand and overshoot there is a tendency for high cost capacity, inexperienced management and inefficient practices to be added. Consequently, the abrupt market contractions occurring in the wind and wider infrastructure markets present an opportunity to eliminate inefficient capacity, firms, and business practices that provide negative or marginal value.
The wind industry’s dramatic growth in recent years was largely fuelled by technology changes, government subsidies and tax incentives, as well as low cost and readily available debt. This led to an industry development structure that is highly splintered and populated with numerous and often small companies with different business models. The survivors from the fall out in turbine demand will be those firms offering the most value and with most efficient cost structures, supply chains, and business models. Moreover, weakened and highly cautious financial institutions will tend to channel capital to the economically stronger companies with solid business plans.
Table 1, above shows how the wind turbine business has become more concentrated over time, with the top five manufacturers peaking in 2004 with an 85% share of the market. Even as the market grew tremendously over the last 12 years the top 10 firms have held on to market share, suggesting a limit to industry fragmentation. Driven by low oil prices and repeated lapses of the US production tax credit (PTC) subsidy, the last consolidation wave occurred over 2002–2005 as Vestas–NEG Micon and Gamesa–Made merged. From 2006 forward, new entrants from the east – the Chinese – entered the market with a few, such as GoldWind and Sinovel, finding their way into the top 10 turbine manufacturers. The Chinese manufacturers benefit by having one of the largest potential markets and a government policy that mandates foreign companies have 70% local production and share their technology.
The wind industry’s rapid growth indicates that while barriers to entry exist, they are not insurmountable. Companies can either enter by acquiring existing players, which is how GE, Siemens, and Alstom entered, or acquire rights to technology as the Chinese have done. This indicates that intense competition is likely to be an important hallmark of the industry’s future and that further consolidation may be difficult, especially as the potential for growth is so large.
The present economic downturn with its significant impact on demand for turbines should serve to accelerate what is already a highly competitive market. Given the large number of global players, there should also be strong competitive pressure to pass on falling commodity and transportation costs, which will be a boon to buyers. Companies with low-cost structures, for example, with access to low-cost country sourcing, should gain a competitive advantage. With transport costs rapidly falling, this strategy may make more sense.
More intense competition is also likely to accelerate specialization, as firms exit businesses for which they do not have a core competency. This should encourage many of the larger and more established firms to re-double their business rationalization strategies. Gamesa for example, sold its solar business in early 2008 and in July announced it had created a joint venture with Iberdrola that would absorb its wind farm business assets. In announcing this strategic decision, Gamesa said it would allow the company to focus ‘efforts on the Wind Turbine Design and Manufacturing division.’
Similarly, other established players can be expected to take advantage of the slowdown to sharpen their technology prowess by purchasing needed expertise and resources at today’s lower prices. Blade and control software are increasingly seen as offering a technology edge. Existing companies such as American Superconductor as well as new ventures like Danotek Motion Technologies have realized opportunities to improve turbine efficiency. Through its subsidiary, Windtec, American Superconductor has developed highly efficient power conversion and power conditioning grid connection equipment. Danotek has introduced its line of permanent magnet generators, up to 3 MW, specifically for wind turbine applications.
Increasing intensity of competition should further test the one-stop-shop business strategies of the capital equipment giants such as GE and Siemens, which are experiencing challenges in the new economic environment. The conglomerate structure tends to come under pressure when markets contract and shareholders demand firms rationalize operations to become more efficient. Although many buyers, particularly large utilities, benefited by going to one firm to purchase different types of generation equipment, the new buyers’ market will put more impetus on sellers to offer additional value and enable buyers to benefit from falling costs.
At the same time, the opportunity for economically stronger firms to expand by buying low cost assets may entice large vendors to grow their wind businesses. Alstom, the world’s third-biggest power plant builder, in November 2008 announced plans to buy parts suppliers and makers of equipment for wind, solar, and biomass energy in Asia. A relatively new entrant, it entered the wind energy market in 2007 after buying Ecotecnia of Spain, which had five factories where it made wind turbines.
Complicating normal market forces are the number of forms of government intervention such as Renewable Portfolio Standards. Presently, 29 US states have RPS. Utilities’ position in the marketplace should grow stronger with the transformation from a buyers’ to a sellers’ market combined with the floor on demand provided by RPS. Those with existing large wind programmes, such as FPL Energy and MidAmerican, should see their position in the market grow. At the same time, smaller sized utilities without the resources or ambition to grow a wind business should be in a better position to negotiate with IPP and wind farm developers.
A baptism of fire?
After growing at a breakneck pace the industry was expected to install 18 GW in 2008. By significantly reducing demand and intensifying competition, today’s global economic slowdown should encourage a shakeout of companies, management teams, and business practices in the wind business. To adapt to the more competitive and lower-cost economic environment wind turbine companies will have to consolidate their ownership and development models. New market economics will drive industry transformation to a lower cost structure, with fewer players, stronger supply chains, and a greater focus on reliability. Higher efficiency and better reliability are especially critical for making the wind generation cost competitive and credible with traditional forms of power generation.
This will be a tremendous benefit for buyers of turbines, and though painful in the short run for wind turbine companies, this economic cleansing process should result in a more stable and resilient long-term business.
An economic crisis can often present the seeds for industry innovation as heightened competition drives ‘disruptive innovation’ in the form of, not only lower prices, but new technologies, business organizations, and service delivery methods. The wind industry is in position to take advantage of these challenges and take the next step down the path toward sustained growth.
Seth Beck is a director at Power Advocate, a Boston, MA-based energy intelligence group. David Haarmeyer, formerly of Power Advocate, is now a freelance consultant. Helpful research support for this article was provided by Simran Dhaliwal.
e-mail: seth.beck@poweradvocate.com and dhaarmeyer@gmail.com
