Winds of change

In the first of a three-part series on alternative energy, Barry O'Halloranconsiders how, as oil and its byproducts get more expensive, other options look more attractive and more viable

The new year wasn't a week old when two records were broken in the world and local energy markets.

The first was oil, which breached the $100-a-barrel mark, the second was the sale of Airtricity's European business to Scottish and Southern Energy (SSE) for €1.8 billion, a record price in Irish and British terms at least.

That deal was struck just three months after Airtricity had agreed to sell its North American division to German power giant Eon for €1 billion.

The week's two events seem to signal that alternative energy is coming of age. As oil, and by extension, gas, gasoline and other products, gets more expensive, other options look more attractive and more viable.

But there are alternatives and alternatives. Some ideas, such as marine power, are barely out of the lab or off the drawing board. Others, such as wind, are regarded as mature businesses, to the point where established power companies such as SSE and Eon are looking seriously at them.

Wind power is the one with which most Irish people are familiar, thanks largely to the clusters of turbines that have sprung up on hilltops around the country. The concept is simple: the wind blows the turbines, all of which are equipped with generators that produce electricity, which is then transmitted into the national power grid.

However, the wind only blows at a suitable speed between 33 per cent and 50 per cent of the time. So wind farms only produce electricity between one-third and half the time, and thus only get paid for generating power between one-third and half the time.

Nonetheless, there's more of them to come, but it's likely that the bulk of future development will be off our coasts. Various groups are planning to invest a total of €4 billion in wind farms around the Republic's coastline. One of the biggest is the Oriel project off 22km off Louth in the Irish Sea. Its backers include Glen Dimplex founder Martin Naughton and former Central Bank director Michael McBennett.

It's going to cost €600 million to build, and will produce 330 megawatts of electricity, roughly the same as a medium-sized power station.

The story across Europe is broadly similar; there's been a high rate of development on land, but the wind farms are beginning to move offshore. Airtricity has plans for the Thames Estuary, North Sea and Baltic.

Other bigger players, such as Spain's Grupo Acciona, the largest operator in Europe, are ramping up development, and buying up smaller rivals with wind farms under construction or at various points throughout the planning stage.

The move offshore stems in part from the fact that the sea can accommodate bigger individual turbines that produce more electricity. For example, typical on-land turbines produce 2MW each; the offshore version generate 5MW.

It's partly because conservationists, planners and people living near proposed onshore sites are beginning to object. Recently the Scottish executive shot down Airtricity's plans for a facility on British businessman Mohammed Al Fayed's highland estate.

The industry is big. According to a comprehensive study of alternative energy produced last month by Davy analysts Jack Gorman and Mark Healy, there are 15 quoted companies in the wind sector.

In November, they had a total value of €56.6 billion. Acciona represented about one quarter of this with a valuation of €14.5 billion, almost on a par with AIB at close of business on the Irish Stock Exchange on Wednesday. Britain's Novera energy nestles at the bottom of the table with a valuation of €114 million.

Interestingly, the next one down, with a €13.2 billion price tag, was Danish manufacturer Vesta, which does not build wind farms, but produces the turbines installed on them and used to make electricity. It and Acciona account for close to half the sector's market capitalisation.

Over the last three years, the value of the sector has trebled, according to Gorman and Healy. It was overtaken last year by solar energy, thanks to a raft of flotations in that sector in Asia, but still increased its value by about 80 per cent.

The Airtricity deal gives some idea of the sort of returns it has delivered for investors. Specialist British fund manager Ecofin bought almost 15 per cent of the Irish group wind energy group in August 2006 for €16.43 a share, which came to about €132 million.

This week it revealed that it expected a return on this of €33 a share or €265 million, a doubling of its investment over 16 months. This is a good return in anyone's language, and makes the sector look lucrative to say the least.

The reality is that Airtricity is still in the very early throes of development. It has over 1,400MW in various stages of planning, and another 438MW being developed in Europe.

It does have functioning wind farms, which in the 12 months to March 31st, 2007, generated electricity and revenues of €177 million. The group had a loss before tax of more than €11 million for the period.

In fact, almost the entire sector is at an early point in its development. And this has been no bar to deals being done. For example, Acciona bought smaller rival Corporacion Eolica CESA in 2006 for €1.37 billion. It had 536MW installed, equivalent to a medium to large power plant and 878MW under construction.

On top of this its "pipeline", which could include facilities that are the subject of an initial planning application to something that is licensed but not built, consisted of 3,400MW.

Figures from the British Wind Energy Association estimate that the cost of building an onshore wind farm runs at €1.275 million per megawatt, while offshore costs are €2.52 million for every megawatt. This means that not only does a buyer or investor have to pay the asking price, they will also have to fork out to ensure these enterprises hit their development targets.

On the basis of these figures it's no surprise that Vesta is the second biggest player in the sector, and accounts for close to one quarter of the value of all quoted companies. A lot of people want to build wind farms; far fewer people are making the hardware they need.

Last week, the company announced it was doing a deal with a Chinese utility to supply turbines with a total capacity of 197.2MW. At current prices, that is worth in the region of €240 million to €250 million.

In light of all this, the kind of prices being paid for wind-farm operators are coming in for criticism. Some of it flowed this week in the wake of the Airtricity-SSE deal. Dow Jones commentator Arindam Nag described it as "bubble-like". Credit ratings agency Moody's argued that Scottish and Southern had paid 7,000 times earnings for the Irish company.

However, Davy's Gorman and Healy see realistic prospects of earnings and profit growth. They suggest that over the 2006 to 2009 period, revenues should grow 21 per cent, earnings before interest, tax and write offs, by 34 per cent and net profits by 12 per cent.

There are other issues too. The wind industry is dominated by European players, but this is not an accident. Most EU governments are underwriting these projects by guaranteeing tariffs for the electricity they produce. Some are willing to spend cash on developing national grids to facilitate these projects, a cost that is passed on to the consumer.

The Irish Government provides some of these supports to onshore wind. Offshore developers are now seeking similar backing. Airtricity executive and National Offshore Wind (Now) Ireland spokesman Torben Andersen pointed out at that organisation's launch last year that the State needed to spend €800 million on the national grid to facilitate offshore projects. In addition, the association wants to see some form of tariff support. Andersen also said that wind projects would not be feasible without this backing.

The cost of doing this will ultimately be passed on to customers, which means they will pay more for electricity. The industry argues that as the price of oil rises, this will cancel out the extra cost associated with supporting their businesses.

Last week's oil price increase will lend credence to that argument. But what it really shows is that energy, no matter where it comes from, costs a lot more than it used to.