BARRON'SOnline.com: Winds of Fortune

MONDAY, MAY 31, 2004
By JACQUELINE DOHERTY

With oil at $40 a barrel, windmills and solar panels are getting a second look

IT USED TO BE A QUAINT DREAM of the granola and Birkenstock crowd: widespread use of windmills and solar panels to generate electricity. But now, lured by the potential profits, some big corporations are starting to plow billions into the field. Giants such as General Electric and Royal Dutch/Shell Group have jumped into the manufacturing end of the business, while wind farms are finding equity financing from the likes of FPL Energy, a unit of Florida's FPL Group; PPM Energy, a unit of Scottish Power; and the Zilkha family of Texas, which made a fortune in natural gas in the 1990s.

"We're in [the wind business] because we think we can make money at it," says Terry Hudgens, chief executive officer of PPM Energy, Scottish Power's U.S. subsidiary. "The convergence of the lower cost to produce wind power along with higher price of natural gas [used to power utilities] has made wind economically attractive."

Indeed, the surging prices of oil and natural gas this year have added real urgency to the effort -- and raised the stakes for everyone from state governments to private investors. Right now, there are no direct plays on the industry for individual investors, but opportunities are sure to arise as the industry moves to fund its expansion.

There is no question that wind- and sun-generated electricity is gaining ground. Last year alone, new windmills boosted total wind-energy production by 36%, to almost 6,400 megawatts. Likewise, the total U.S. capacity of solar power jumped 21%, to 218 megawatts. Though wind and sun power still account for less than 3% of all electricity produced in the U.S. -- coal-fired, nuclear and natural-gas utilities firmly dominate the field -- the new markets should keep growing at a blistering pace. Some consultants figure that wind and solar each will grow 20% annually for the next five to 10 years.

This surge of activity is the result of simple economics. In the mid-1980s, it cost about 10 cents per kilowatt hour to produce electricity from windmills. Today, thanks to technological advances, the cost has shriveled to about five cents, which is equal to the cost of producing electricity from a natural-gas-fired utility now that natural-gas prices have surged above $6 per British thermal unit, or BTU.

Wind energy remains more expensive than the 3.5 to 4 cents per kilowatt hour it costs to generate electricity from a coal-burning utility, but perhaps not for long. GE, which bought Enron's wind operation out of bankruptcy in 2002, aims to reduce the cost by another one cent, says John Rice, head of GE Energy.

Solar energy remains almost prohibitively expensive to produce, at 20 to 30 cents per kilowatt hour. Despite this, GE recently purchased AstroPower, a maker of solar products, for about $19 million. Again, GE is betting its manufacturing expertise and experience with materials can help it slash costs. By the end of the decade, Rice says, GE hopes to get the cost of solar down to eight to 12 cents a kilowatt hour.

GE's involvement in renewable energy already is having ripple effects throughout the field. "We think GE's entrance into the business is an affirmation of the health of the wind-energy business," says Jay Godfrey, director of business development for American Electric Power, one of the country's largest producers of electricity. "It has served to increase the competition among manufacturers."

Certainly, Royal Dutch/Shell Group has been stepping up its activities. In 2002, it purchased a solar business from Siemens, and four years ago it started up Shell WindEnergy. It also makes equity investments in wind-power projects.

Why? When it looks into the future, Shell sees the availability of oil declining beginning in 2020, and it believes renewable energy sources will make up for the decline, says Jeremy Cohen, a vice president at Shell International Renewables, a unit overseeing wind and solar initiatives.

As always, investors and companies in the field of alternative energy face formidable political risks. Most notably, a federal production-tax credit for wind projects, which provides a 1.8-cent credit for every kilowatt hour of electricity produced, expired at the end of 2003. The credit brings the cost of wind power down from five cents to 3.2 cents per kilowatt hour on an after-tax basis. An extension of the tax credit through 2006 was passed by the Senate, but the plan has become mired in the House of Representatives.

"We have opportunities in the pipeline, but everyone is frozen in time because of the delay in passing the production-tax credits," laments AEP's Godfrey. "It's hard to build a project with regulatory uncertainty."

Randall Swisher, executive director of the American Wind Energy Association, is hopeful the bill will pass by year end. But the chaos created by such snags prevents some companies from even entering the market and may make financing more costly, participants say.

One of the largest projects in limbo is a 310-megawatt wind farm planned for Iowa by MidAmerican Energy, a unit of Berkshire Hathaway and the latest entrant into the market. The company had expected to start the $323-million project this year, but it will put construction on hold until the tax credit passes, says Jack Alexander, senior vice president of supply and marketing at MidAmerican.

But if Uncle Sam has been dragging his feet, states have been doing plenty to boost demand for alternative energy. Fifteen states have mandated that at least some percentage of their energy be produced by renewable energy sources, and more states are expected to join the trend.

New York Governor George Pataki last year announced a goal of generating 25% of the state's power from renewable sources by 2013. About 15% of the state's electricity already comes from hydropower. If wind power is to make up the difference, that would mean adding about 3,000 megawatts of wind energy capacity -- up from just 48 megawatts now. The tab for the expansion could hit $3 billion.

Many wind farms are first developed by small companies that specialize in the area. One of the most intriguing players is the Zilkha family, which owns Houston-based Zilkha Renewable Energy. In the early 1900s the family was known for its banking empire, which stretched from Baghdad to London and New York. Selim Zilkha, 77 years old, made his mark on the energy business by buying a company for $39 million, which he renamed Zilkha Energy. Now the family is betting on wind power and is actively scouting for options on leases or actual leases on desirable land. By some estimates, the Zilkhas own the most options on land in the industry.

In all, more than $2.7 billion of equity has been sunk into wind farms, primarily in the last three years. As the industry matures, the financing of these projects grows more sophisticated as well. Wind-power projects have historically been financed through a combination of private equity and bank debt. But for the first time last year FPL Energy sold three bonds -- one garnering an investment-grade rating -- to raise a total of some $620 million.

"For many years wind was seen as a lab experiment or a niche business," says Mike O'Sullivan, a senior vice president at FPL Energy. "We wanted to show it was financeable and legitimate."

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