Largely overlooked in the coverage of the fiscal cliff was the expiration of a little-known, but critical, tax subsidy for wind energy producers. Many wind energy companies expected the credit, which has propped up wind power intermittently for two decades, to lapse without being extended. Industry experts therefore predicted a 90% decline in new wind installations in 2013; however, in the early hours of the new year, an extension of the PTC was indeed passed. This policy shift has set up 2013 and 2014 to be banner years for wind power, an unexpected boon to many wind companies and one of the reasons I believe General Electric (GE 1.30%), the nation's largest manufacturer of wind turbines, is the best renewable energy buy right now.
The production tax credit, or PTC, has helped to make wind turbines competitive and profitable by providing a 2.2 cent credit for each kilowatt-hour a turbine generates in its first 10 years of operations. While the cost of wind power has dropped dramatically over the past few years, the policy is still considered essential by many wind power producers. Historically, to benefit from the PTC program a wind energy producer must have its turbines operational and feeding power into the electricity grid before the policy expires. So, energy providers anticipating the expiration of the policy at the end of 2012 raced to install new capacity. A record 12,000 MW of wind capacity came online in 2012, making wind power the largest contributor to new electrical generation with 44% of all new electricity, eclipsing natural gas at 30%.
The flip side of this frenzied activity is that, with the future of the PTC uncertain, developers across the country basically shelved any plans for 2013 and beyond. If it couldn't get done in 2012, the assumption was that it wasn't getting done. The PTC has expired three times before since its introduction in 1992 before eventually being renewed, and each expiration caused new wind installations to fall dramatically, between 73% and 93% before eventually rebounding when the credit was reinstated.
This time around, it was far from certain the credit would ever be reinstated. The policy has garnered some powerful opponents, not only from expected corners like conservative or libertarian political think tanks, but from within the energy industry itself. Exelon (EXC -0.29%) is well-known as the nation's largest producer of nuclear energy, but the company is also the 11th-largest producer of wind energy and as such was an early member of wind trade group the American Wind Energy Association (AWEA). However, in 2012 Exelon spent $6.4 million lobbying against the extension of the PTC, arguing that the policy distorted energy prices and hurt its bottom line. Exelon's view that subsidies for wind were "displacing other clean generation in the market," meaning its own nuclear, resulted in the company being booted from the AWEA in September, but that hasn't diminished Exelon's clout.
Exelon's lobbying sum easily eclipsed the $1.8 million that AWEA spent lobbying for the PTC, as well as the nearly $3 million spent by NextEra Energy (NEE 0.51%), the nation's largest renewable energy producer. Not only do wind energy lobbyists appear outgunned, but the industry itself admits the subsidy will eventually have to end. The AWEA proposed in December that the PTC be phased out over a period of five years, ending with a fully independent wind industry in 2019.
With over 40% of the American wind turbine market, this situation led General Electric to issue some dire projections. The highly diversified industrial conglomerate warned in an annual outlook meeting (PDF) last month that falling wind sales alone would shave off 300 basis points of growth from the company's critical industrials segment, which accounts for 55% of total revenue. A bad wind outlook dropped organic revenue growth from a robust 5%-9% to only 2%-6%. Combined with flat or down revenue from GE Capital, which General Electric is intentionally shrinking in order to favor industrials, wind's dour outlook made General Electric as a whole look exposed to underperformance.
Now the picture looks very different. Since wind farms can take 18-24 months to become operational, a one-year extension actually wouldn't have helped the industry except for one important change: The new legislation grants the tax credit to any wind development which begins construction in 2013, rather than any development operational in 2013. While the industry still has to wait for the IRS to rule on exactly what constitutes "beginning construction," it seems very likely that the new rule will benefit projects that come online not only in 2013, but years into the future. It may even be possible for developers to "bank" the credit, perhaps just by breaking ground on enough projects in 2013 to keep a developer busy for a decade.
That development would require thousands, or even tens of thousands, of new wind turbines in North America, where GE is the established market leader. At a stroke, General Electric's worst-performing unit over the next few years could become its best-performing unit. Combined with the resilience of the company's diversified industrial portfolio, a robust dividend yield over 3%, and shares that look undervalued at a forward price to earnings ratio of 10, today looks like a great time to bet on General Electric, a venerable old blue chip and a renewable energy industry pioneer.
