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Pattern Energy Group (NASDAQ:PEGI)
Q4 2018 Earnings Conference Call
March 1, 2019 10:30 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good morning, ladies and gentlemen. Welcome to Pattern Energy Group's 2018 fourth-quarter and year-end results conference call. [Operator instructions] I would like to remind everyone that today's discussions may contain forward-looking statements that reflect current views with respect to future events. Any such statements are subject to risks and uncertainties that could cause actual results to differ materially from those projected in the forward-looking statements.

For more information on Pattern's risks and uncertainties related to these forward-looking statements, please refer to the company's 10-K, which will be filed later today and available on EDGAR or SEDAR. I'd now like to turn the call over to Mike Garland, president and chief executive officer of Pattern Energy Group.

Mike Garland -- President and Chief Executive Officer

Thank you, operator. Good morning, and thank you for joining us today. Earlier this morning, we released our 2018 fourth-quarter and year-end results, which you can find on our website at patternenergy.com. You can also download a copy of the presentation of the company's today's call from our website by selecting Invest, then Events on our web page.

I am starting my comments on Slide 3 in the presentation. 2018 was a solid year. We exceeded our midpoint of our guidance range from recording $167 million of CAFD, cash available for distribution, despite lower-than-anticipated wind resource in Q4. In addition to covering Q4 and annual performance, we use this call to give you guidance as to our outlook for next year's CAFD.

Today, we are doing something more than we had in the past, which is to give you two years of guidance. We are doing two years because we believe it is important for investors to understand how we share outlook and our commitment to growing our CAFD per share. Our 2019 CAFD guidance range is $160 million to $190 million with a midpoint of $175 million. And our 2020 CAFD guidance range is $185 million to $225 million, with a midpoint of $205 million of CAFD.

This CAFD outlook results in a 10% CAFD per share per year growth for the next two years and gets us to our targeted 80% payout ratio. As part of this growth, we start to see gains reported in 2019 from our Pattern Development investment, which will not affect our 2019 CAFD and material distributions from Pattern Development in 2020. In addition, we announced this morning that we have added 400 megawatts of New Mexico wind projects to our identified ROFO, Right of First Offer list. These projects have signed our sales agreement for delivery to purchasers in the California market.

This expands our iROFO list to 1.4 gigawatts. With these core messages through this earnings call, let me briefly address the highlights from 2018 on Slide 4. Our CAFD of $167 million is up 14% year on year and slightly exceeded the midpoint of our guidance range of $166 million. Our adjusted EBITDA was $372 million, up 8%.

This morning, we announced a quarterly dividend of $0.42 -- $0.422 per common share for the first quarter of 2019, which is unchanged from the prior period. On the safety front, our total recordable incident rate was 1.6 at the end of the year, which is good, but our internal culture is to drive it to zero. On the growth front, we acquired more than 315 megawatts of assets in 2018, highlighted by our entry into Japan market earlier in 2018 and the 206-megawatt acquisition of five projects in addition to acquiring Mont Sainte-Marguerite and Stillwater here in North America. We successfully executed on our asset rotation strategy with the sale of El Arrayán and K2 for proceeds of $230 million at multiples that provide us opportunity to make accretive new investments.

We continue to execute on our cost improvements plan, including our O&M initiatives and ERP implementation, which is ongoing, and reduced our operating costs by $12 million in 2018 compared to our budget. And lastly, we are excited about the growth opportunity from Pattern Development, where we've invested $183 million to date, which I will address in more detail in a minute. On Slide 5, we outline the variance from the midpoint of our 2018 CAFD guidance to our actual 2018 result. Our existing operations were down about $5 million from our initial guidance expectations resulting primarily from some production underperformance, but largely offset by cost improvements at both the projects and our corporate operations.

We made two new investment acquisitions subsequent to the March call last year, which provided some additional income, even more significantly are our Japanese assets outperformed our initial expectations. Together, these resulted in about $6 million more cash available for distribution than we included in our guidance last year. Taking together, these variances resulted in $167 million in CAFD for 2018, which represents a payout ratio of about 99% for the year. On Slide 6, we provide our CAFD guidance for the next two years, 2019 and 2020.

As you can see, 2019 is a building year with CAFD per share growth of approximately 5%. There are two primary headwinds that we are managing in 2019, which we have pointed out in previous calls. The impact of Gulf Wind hedge rolling off and the continued congestion in ERCOT. We are taking several steps to offset these headwinds and actually grow our CAFD per share, while at same time maintaining our current dividend level and improving our payout ratio.

All together, we expect to increase in cash available for distribution at our existing operations of about $16 million in 2019. The primary drivers for this increase are higher revenues based on better production in 2019, compared to 2018 come with a contingency of 1% to 2%, a modest change in operating expenses and an increase in our other cash flow uses, such as global increase in principal payments at certain projects. We expect that the long anticipated expiration of the Gulf Wind hedge will reduce CAFD by about $7 million this year, a lower impact than we had previously indicated due to the improving outlook for summer pricing at ERCOT. We will also have some residual drag on CAFD in 2019 arising out of our divestitures at El Arrayán and K2.

Finally, we anticipate using some of our liquidity to make drop-down acquisitions around midyear that can generate about $5 million of accretive cash flow. In 2020, we'll start to receive increased benefits from our investments, including drop-downs, cost improvement, balance sheet optimization and first distributions from Pattern Development. As Slide 6 indicates, we expect to add incremental cash available for distribution as compared to 2019 using new or recycled capital to add about $15 million in annual cash available for distribution. We also expect that we'll begin to receive significant cash distributions from Pattern Development, which by 2020 should exceed the partner's need for new capital development expenditure.

Based on our business plan, at Pattern Development, we are projecting $17 million of CAFD contribution in 2020. The midpoint of our 2020 CAFD guidance range is $205 million. As the result of our CAFD growth without any new common equity issuances, we expect CAFD per share growth of about 10% annually. At $205 billion CAFD, our payout ratio at the current dividend level is driven down to our targeted 80%.

At this time, the board has not made a decision whether to maintain or increase our dividend over this period. So let me give you a little color on how we deliver the growth. Starting on Slide 7, we have assumed out of the nearly 500 megawatts of projects on the iROFO list that have commenced and will commence commercial operation by 2019, we can make acquisitions that will generate approximately $5 million in the increased CAFD after capital charges in 2019. The kind of growth we can achieve through acquisitions will be dependent on our cost of capital and economics of the projects, not access to quality projects.

We have already acquired the Tsugaru wind project in Japan, which is on schedule for commissioning in mid-2020, and we have also committed to repower Gulf Wind. Our plans for Gulf Wind would see us begin repowering near the end of this year or early 2020 with completion midyear, which is a change from completing repowering early 2020. We also continue to evaluate the opportunity to recycle all or a portion of the Gulf Wind asset, but no final decisions on that matter have been made at this time. As I mentioned, the primary determinant is how much acquisition growth we have is access to capital at reasonable costs.

We are currently planning on not raising any common equity in 2019 or 2020 given our current share price. However, there are many ways to raise capital for acquisition. Slide 8 issue a list of the capital we are evaluating. We are committed to maintaining a conservative fiscal policy.

We have approximately $200 million in liquidity available at present for drop-downs, investment in Pattern Development or paying down debt. We intend to expand our access to capital through a range of potential options, including co-investment structures, asset recycling, hybrid equity and further optimization of the mix of our corporate and project capital, including monetizing a portion of our course ownership in the Japanese portfolio. In Japan, our current thinking is that we should wait until the commissioning of Tsugaru approaches in early 2020 to recapitalize the portfolio and use the proceeds to fund the acquisition of additional projects either in North America or Japan. We believe multiple alternatives exist for us to fund between $300 million and $500 million for growth without accessing common equity.

We will not use all of these options. The list is indicative of the options available to us. On Slide 9, we reiterate our continuous commitment to improve our business processes and covering additional cost improvements. There is a significant leverage within the business today to grow the portfolio while improving our cost structure.

On the self-perform initiative, we transitioned five projects to self-perform in 2017. No projects came up for service agreement renewal in 2018. At those five projects, our turbine maintenance expense in 2018 was about $5 million lower than in 2017. Currently, we are scheduling one project in 2019 to move to self-perform as the broad view project where our original service agreement expires later this year.

We also anticipate transitioning more projects to self-perform in 2020. We have also demonstrated an ability to leverage our operating platform by maintaining our operational role at K2 for a fee. We believe additional opportunities exist for both our existing portfolio to recycle select assets or within the iROFO list to take a smaller ownership position at select projects, each while still earning a fee to operate them. We're also implementing improvements to automate processes through our ERP system and optimize our back office administration for which we are confident we can deliver savings.

In fact, we went live on our new ERP system on February 11 with our foundational processes and we will be building on that foundation this year and for years to come. Additionally, our operation team continues to drive down costs, reducing our project expenses by more than $8 million this year compared to guidance. As we implement our cost improvements, we are also making improvements to our work environment by providing our employees more efficient means to do their work, better places to work, greater communications and more employee recognitions. These improvements afford the goal of ensuring Pattern Energy is the best place to work in our industry.

The key element of our growth outlook is Pattern Development. On Slide 10, we have two -- on Slide 10, we identified two benefits, two primary benefits from a strong successful development business. First, increased opportunities to buy attractive projects, and secondly, a return on our investment in Pattern Development. To reiterate, we believe well-done development offers the best risk-reward profile in the renewable value chain.

Pattern Development targets IRRs of at least 15%. We own a 29% interest in the business and have invested $183 million to date. We expect that investment to begin generating its first meaningful returns to Pattern Energy in 2020. Pattern Development has a pipeline of approximately 10 gigawatts, including qualifying for 453 megawatts of new FiT contracts in Japan and an expanded solar pipeline of one gigawatt.

Additionally, we we announced today that our iROFO list has grown to 1.4 gigawatts with secure power contracts, including the new 400 megawatts of wind projects in New Mexico. With the good progress we are having at Pattern Development, we expect to report meaningful transaction gains this year at Pattern Development. These gains will come from the sale of projects already on the project development portion of the iROFO list, such as Grady and Crazy Mountain. But also from projects that we have not included on the list in which we do currently expect to take an ownership interest, we do not currently expect to take current ownership interest over there, including solar projects in Mexico and the United States.

And as it relates to the asset in Mexico pending the change in the competitive environment in that region, we are more likely to waive iROFO on these assets and subsequently benefit from their sale to a -- and a profit to third-party operators through our ownership in Pattern Development. Although we anticipate that proceeds of these sales will be reinvested back into Pattern Development's business in 2019, the gains will be reflected on its income statement for the year. This sets the stage for 2020 when its investors anticipate their first distributions over and above what is reinvested in the business. We continue to believe these distributions will increase our CAFD in a meaningful fashion, which will result in CAFD per share growth and drive down our payout ratio.

We believe our ownership interest in Pattern Development is a unique component of our long-term growth, it is also a clear differentiator for our business model relative to other companies in the U.S. to which we are often compared, which do not have the potential income from development. At this point, I'd like to turn it to Mike Lyon to review the financials in more detail. Mike?

Mike Lyon -- Chief Financial Officer

Thank you, Mike. Let's start with electricity sales. We report electricity production on a proportional basis to reflect our ownership interest in operating projects. Proportional gigawatt hours sold was 1,967 gigawatt hours in the fourth quarter of 2018 compared to 2,130 gigawatt hours in 2017.

The change was primarily due to the sale of El Arrayán, the change in our ownership level at Panhandle 2 and lower production due to weaker-than-anticipated wind resource levels. In the fourth quarter of 2018, wind resource across the portfolio was 12% below our long-term average expectation and production was 14% below long-term average, compared to 4% below and 9% below respectively in the same period in 2017. Wind resource was weak throughout the portfolio with greatest pressure in the Eastern United States and Western United States during the fourth quarter. Moving on to cash available for distribution, we achieved $35 million and $167 million in the fourth quarter of 2018 and the full-year 2018, compared to $42 million and $146 million in the corresponding periods in 2017.

With this result, we exceeded the midpoint of our 2018 cash available for distribution guidance range. Referring back to Slide 5, we have bridged the variance from our 2018 CAFD guidance to our actual results. You can think of this chart as showing how we did in 2018, compared to what we said on our 2017 fourth-quarter earnings call. A couple of points I'd highlight here in terms of that bridge.

From existing operations, we underperformed against guidance by $5 million. Revenue was lower by about $21 million, but was nearly offset by lower incurred costs. Revenue was principally affected by low wind of about 5%, but also by grid outages and offset by slightly higher average electricity rates. Congestion impact was about what we expected for the year.

We talked on earlier calls about cost reductions initiatives. We beat guidance by $12 million in costs, $8 million in project expense, driven primarily by self-perform and property taxes and $4 million in G&A costs. Relative to our guidance, we earned about $6 million more cash available for distribution in 2018 than initially expected from new acquisitions. This includes outperformance in Japan, as well as modest contributions from our Mont Sainte-Marguerite and Stillwater acquisitions.

The net impact of divestitures was essentially neutral during 2018. This morning, we provided our cash available for distribution guidance for the full year of 2019, which we had established as $160 million to $190 million with a midpoint of $175 million. The midpoint represents a payout ratio of 95% based on the current dividend level. As Mike mentioned, we are also providing our 2020 guidance range for cash available for distribution, which we've established as $185 million to $225 million with the midpoint of $205 million, which presents compound annual growth rate of approximately 10% on a CAFD per share basis over our 2018 result.

The 2020 midpoint represents a payout ratio of approximately 80% based on the current dividend level. As Mike mentioned, we could achieve these growth targets without issuing new common equity. Referring back to Slide 6, we provided a bridge from our actual 2018 cash available for distribution to the midpoint of our 2019 and 2020 guidance ranges. A couple of important points to note about 2019.

From existing operation, which now includes our 2018 acquisition, our guidance includes an increase over 2018 results of about $16 million net. This includes about $25 million of incremental revenue and $7 million of other items, including increases in scheduled principal payments. Our revenue indication reflects our expectation that 2019 will be more consistent with our 2018 expectation rather than our 2018 actual wind resource, as well as a repeat of last year's wind contingency of 1% to 2% of long-term average. We expect ERCOT congestion to continue to drag on our revenue, but perhaps a few million dollars less than in 2018.

Our net change in cash from existing operations reflects around $2 million from specific ongoing process improvements. Second, we've also estimated about a $7 million net reduction in revenue arising from the expiration of the Gulf Wind hedge. This is lower than we have previously estimated as we are currently seeing higher summer spot prices than we have been expecting. We assume a net divestiture impact of about a $5 million impact on annual cash available for distribution in 2019.

This includes the loss of cash flow from K2 and El Arrayán and is partially offset by the lower debt service due to our recent prepayment of the Spring Valley project loan and contributions from our investment in Stillwater. Remember that we have also applied sales proceeds into further investment and to development or repayment of revolver draws previously used for that purpose. Lastly, we assume $5 million of contributions to cash available for distribution in 2019 from new investments yet to be made, which we expect to make in or before the third quarter of this year. Reaching from the 2019 result to the midpoint of our guidance for 2020, the major drivers of the growth are an increase in earnings from new acquisitions and investments.

We believe that we'll be able to tap capital resources, but not common equity in forms that will allow accretive investment. We project a contribution of $15 million net of carrying charges or lost recycled cash flow. We've discussed our funding possibilities earlier in this call. Second, distributions from Pattern Development, which we believe will make a meaningful contribution to our cash available for distribution for the first time.

We believe, based on our business plan and Pattern Development, that it is very reasonable to expect our share partnership distributions to be $15 million to $20 million and our bridge reflects an assumption of $17 million. Lastly, we're projecting a net reduction of about $2 million on existing operations. This reflects normal wind subject to a modest contingency as we have recently been adopting. We have kept our operation costs close to flat, repowering Gulf Wind and other project specific changes over time.

As we approach 2020, we expect to produce increased visibility to incremental projects and process improvements, but we are choosing to be conservative in our thinking about those opportunities for now. We are confident in our ability to manage the business to achieve these target ranges, which will drive down our payout ratio to our target of approximately 80% assuming no increase in our dividend. And to do so without the need to issue new common equity. As of December 31, 2018, our available liquidity was $735 million, which consisted of approximately $101 million upon restricted cash on hand, $22 million of restricted cash, $205 million available under our revolving credit agreement, $270 million of available undrawn capacity from certain projects' debt facility and $137 million of project facilities for post construction use.

As of February 22, 2019, the amount available on the revolving credit agreement was $165 million. As we acquired new assets, we intend to draw on the revolver to fund those transactions. After considering changes subsequent to the end of the period, our capital available for new growth is approximately $200 million to date. Thank you, and I will now turn the call back over to Mike Garland.

Mike Garland -- President and Chief Executive Officer

Thanks, Mike. We exceeded midpoint of our 2019 CAFD guidance despite weaker-than-anticipated wind resource in Q4. This outcome does demonstrate our ability to manage the business to meet our business objectives. During 2018, we funded new acquisitions like our entry into Japan, Mont Sainte-Marguerite and Stillwater, invested in Pattern Development and paid down debt through the success of our asset recycling strategy and cost improvements.

Our assets continue to operate well, with 97% turbine availability. We have set a path for CAFD per share growth of approximately 10% on a CAGR basis through 2020, without the requirement of new common equity, driving down our payout ratio to approximately 80%. We believe our opportunity in Japan and our investment in Pattern Development will contribute materially to our business in 2020 and beyond and our material ownership interest in the development business is a clear differentiator to the other players in the market. Before cutting it over to your questions this morning, we also announced changes in the responsibilities of our executive team to further optimize our strength and better position us to achieve our corporate goals for growth and operational excellence.

Effective April 1, 2019, the board of directors have appointed Mike Lyon to the role of president, Pattern Energy and Esben Pedersen to the role of chief financial officer. I have retained the role as chief executive officer. I will be dedicating more of my time to focus on strategic initiatives that will drive growth and generate substantial value in the long term for our shareholders. Mike Lyon is charged with continued effective operation of the day-to-day business and executing our business plan, and Esben will be responsible for capital strategy, financial planning, reporting and the financial operations of the business.

Each of us are excited about our roles and aligned in our vision to deliver to shareholders. Our team continues to work every day, guided by our values that focus on community and culture, safety and health of the environment. We also strive to act in a manner that is true to these values and are committed to delivering on what we promised. I like to thank the shareholders.

We have a plan for creating long-term value for the investors, changing the way electricity is made and transferred in developed countries, while respecting the communities and the environment where our projects are located. With that, I'd like to open it up to questions. Operator? 

Questions and Answers:

Operator

[Operator instructions] You first question comes from the line of Brian Lee from Goldman Sachs. Your line is open.

Brian Lee -- Goldman Sachs -- Analyst

Hey, guys. Thanks for taking the questions. Mike, maybe first off, just can you -- I know you talked about this to some degree, but could you level set us, it looks like you came in about 9% below the LTA in 2018 overall. It sounds like you're assuming that 2019 gets back to what you originally thought 2018 was going to be, but then that would imply some improvement.

But could you level set us again as to what that -- if you could quantify that in terms of the production performance you're assuming and the guidance range for '19 and all and then I guess also similarly for 2020, is it flat off the 2019 assumption or are you assuming that there is a bit more improvement into the 2020 guidance ranging as well?

Mike Lyon -- Chief Financial Officer

Sure, Brian. Thank you for the question. We will continue to apply a smallish contingency as we did this past year in 2019 guidance, where we've applied nearly a 2% contingency against our long-term average expectations. So we are expecting an increase in production based on resource and I think we'll have I think some narrowing of the spread between production LTA versus the wind resource and a resource index that we've reported on.

So we do expect an increase year over year into this year and then next year we expect will also be generally in accordance with our long-term average subject to the contingency. But I think it's important to clarify though, people use LTA and it implies wind as opposed to what our production levels are. Wind was down by 5% over our expectation.

Mike Garland -- President and Chief Executive Officer

After taking into account the contingency, that's correct.

Mike Lyon -- Chief Financial Officer

Yes. So it wasn't down 9% as always, there was a grid downtime and other congestion that resulted in the production being less, and we think some of that will be going away because it sounds like it has to do with transmission repair and other things to some of our major projects that we don't anticipate will be ongoing. It was a onetime repair by the utilities as an example.

Brian Lee -- Goldman Sachs -- Analyst

OK. So that's fair enough, so 2% contingency and then anything above and beyond that that's somewhat out of your control. OK. That's fair enough.

Maybe a couple more questions here. Just on the $17 million or the $15 million to $20 million range of distributions expected from Pattern Development in 2020, two questions on that. How much incremental investment is still required on your part and how does that phase in between 2019 and 2020? And then is there any transparency you can provide around what the components are that sort of get you to that midpoint of being able to achieve $15 million to $20 million in distributions from that investment in the 2020 timeframe?

Mike Lyon -- Chief Financial Officer

We have a lot of trends -- visibility into it. It's a private company and so we can't release a lot of information. I think you can look at some of the comments we've made over time around what assets are coming on. So you can look at, for example, the iROFO list as an indicator of projects that are starting to reach maturity to the point where they can be monetized, and so, but we don't publish a list that here are the 10 projects over the next two years that will be reaching monetization point or sale point.

I would say that you're going to get a growing visibility into what we refer to as transactional beatings from realizations of project. Still wondered with the first of these in 2018 in my mindset represented a milestone. And over the course of this year, as we report our quarterly results at Pattern Development, that has picked up within Pattern Energy, you will see a growing level of monetization or a transactional bridge reflected in those results. And that will, I think, give you a greater sense of what's to come in 2020.

I did want to go back to maybe a parting remark you made about the wind resource where you said that above the 2% contingency is beyond our control. I think if we've demonstrated anything over the past few years, it's that we work awfully hard to manage our business to improve our results to offset any downside that occurs with -- that may occur in the wind resource as it arises from time to time. And I think we've established a pretty good track record of hitting our targets notwithstanding weakness temporarily that occurs in resource and we'll continue to work hard with that objective in mind and that may create upside rather an offsetting wind resource shortfall if they occur.

Mike Garland -- President and Chief Executive Officer

Hey, Brian. Also on the Pattern Development transparency, we're likely to do an Investor Day and give you more information during that meeting. We'll have a material amount of time spent on describing the activities of Pattern Development. And so you may get a much better feel for which projects and where we anticipate a lot of monetization or value creation coming out of Pattern Development at that time.

So we just haven't published anything to date.

Brian Lee -- Goldman Sachs -- Analyst

OK. That's helpful to know. And then just on the incremental investment, could you address that part of the question?

Mike Lyon -- Chief Financial Officer

Brian, we only expect modest incremental investment in 2019. This will begin the course on what happens at Pattern Development and if really unexpected good things happen that require more capital, we won't be shy about putting our liquidity into that. And we still think that's the best thing we can do with the capital available to us. But at least at this point in time, we will only have modest incremental investments in the coming months.

Mike Garland -- President and Chief Executive Officer

Yes. And what we've said is in 2019, we anticipate gains being reported, that is gains at Pattern Development. And that's a result of selling assets, and those funds, I think we've been pretty clear those funds are going to be reinvested in development. That's why we don't think the LPs will necessarily have and ourselves a need to do a lot of capital calls.

We've also put in place a funding facility that allows us short-term draws to where we can manage short-term capital requirements of Pattern Development so that we don't have, call it, in seasonality, a lot of putting money in and recycling it very quickly after that. So we are trying to manage the amount of capital our investors have to put up in 2019 and as Mike said, if something terrific happens, we have a lot of opportunities that could change right now. We're pretty optimistic we'll make enough money and we can manage the short-term additional draws that we need through the facility that we arranged, so things seemed to be in pretty great shape from that standpoint.

Brian Lee -- Goldman Sachs -- Analyst

OK. Great. Maybe one last housekeeping one and then I'll pass it on. I noticed the CAFD walk that you guys provide in the financials, you adjusted the starting point from CFFO to EBITDA I think for the first time this quarter.

Anything to read into that and beyond sort of change starting point, is there any adjustments to the CAFD assumptions or just methodology?

Mike Garland -- President and Chief Executive Officer

No. As I said, this is always the final one. So no, the answer is, we get the same result notwithstanding avenues at different starting point in the metric and we're representing our historical numbers under the new calculation with the new reconciliation back to net income and getting the same result historically. This was driven mostly by our growing since the -- not only we, but we think others in the industry, we really think of this as a performance indicator and under sort of the SEC distinction between performance measures and liquidity measures, we think it is best used as a performance measure.

We described some of this in the 10-K that we will be filing a bit later today in our management discussion and analysis. So I'd encourage you to read that and you'll get a little more sense of how we think about it and how we think others use it.

Operator

Your next question comes from the line of Ben Pham from BMO. Your line is open.

Ben Pham -- BMO Capital Markets -- Analsyt

OK. Thanks. Good morning. I had a question about -- Mike Garland, you kind of shifted your focus toward strategy growth and I'm curious how are you thinking about the appropriate long-term payout because I guess you've got a lot of hindsight now, you've been through this massive change and sentiment on the capital markets side, you've seen there's wind resource volatility and now you're getting some development, which could draw on more cash.

So is this 80% really the right target for you guys long term or, I think, naturally it might be a bit lower than that?

Mike Garland -- President and Chief Executive Officer

You know it's a debate we always have. There is a lot of investors who think that we should be putting more money into like Pattern Development and having a higher payout ratio -- or a lower payout ratio, I guess, higher margin to be able to reinvest through cash flow as opposed to access in capital markets or markets of any kind. And it's a debate we're going to be having going forward, but while we have traditionally been a dividend-oriented company focused on predictability of our cash flows and so on, we think that that's still the case, but the philosophy is there. I don't think we're going to see any change in our dividend policy, and so it's really how do we grow our CAFD to improve our payout ratio and then there's the trade-off between you grow your dividend, that's why you're improving your payout ratio.

So in our discussion this morning, we talked about getting down over the next two years to an 80% payout ratio, that assumes a fairly flat dividend policy, and then the trade-off is, if you want to improve your payout ratio, you can't grow your dividend as high. So we're just going to be evaluating that over the coming months to see if whether that strategy is for us, we think right now, we don't see a change, but we're going to be evaluating it.

Ben Pham -- BMO Capital Markets -- Analsyt

OK. That's helpful. And then on...

Mike Garland -- President and Chief Executive Officer

And just to be clear, we're not evaluating cutting our dividend. We always get these questions whenever we say we're going to think about our dividend, people go, "oh, is that trick -- is that code for cutting?" The answer is no. Once again, no, no, no. So just to be clear about that, but your point is a good one.

Is this a trade-off, whether we drive our payout ratios or improve our dividend so.

Ben Pham -- BMO Capital Markets -- Analsyt

Yes. OK. Also I was thinking maybe there is also got Phase I get to 80% and there is a phase two beyond that to get lower.

Mike Garland -- President and Chief Executive Officer

Yes, there will be. But right now, that 80% is for the next two years and that's all we're really talking about this happening over two years.

Ben Pham -- BMO Capital Markets -- Analsyt

OK. And then on the last question on the distributions, I guess, the way I'm thinking about thing is, I mean, the visibility for you guys is pretty good because you can either -- now, I assume that distribution is predicated on some drop-downs specifically to you or I guess what could happen is, Pattern Development, you could just sell those assets and see -- that's where you got that great visibility. I just wanted to check that and I guess the only difference then is really the net investments in that bridge may be different?

Mike Garland -- President and Chief Executive Officer

Right. Whenever projects mature to the point where they could be sold to PEGI or to the public or to third parties, I should say not public, Pattern Development considers their options and they're not oriented to hold assets medium or long term. So typically somewhere around the time of construction start there, we're evaluating whether there should be something on the timing of selling an asset and so all the distributions are created out of that assumption that Pattern Development is not going to be holding assets much past COD, commercial operation date. So but I think we're assuming a fairly modest amount of sales during the next two years relative to what we could potentially do.

But it's a solid, it's based on our business plan of what is our minimum expectations for the next two years.

Ben Pham -- BMO Capital Markets -- Analsyt

OK. All right. Thanks for the '19-'20 bridge.

Operator

Your next question comes from the line of Rupert Merer from National Bank Financial. Your line is open.

Unknown speaker

Thank you. Hi, good morning. I'll be speaking on behalf of Rupert. My first question is on the offshore wind market in Japan.

You previously mentioned that you were looking for a partner there, and now with Futtsu having joined forces with TEPCO, how is the competitive dynamic looking like?

Mike Garland -- President and Chief Executive Officer

We were talking to a number of people, it really depends on how you look at things. I don't think that you were said TEPCO deal matters to us. In fact, I think it's only right now for 1 project, I could be wrong, or one area, and so we don't see that as a problem in fact. If anything, we look at regional players, both major players and utilities to work together with and TEPCO in terms of offshore is only a small part of that market, and in fact we've talked to TEPCO about working together potentially on other projects.

So we don't see that relationship as an issue for us, and we are in discussions with a number of parties and we haven't made any decisions about who are the best parties for the various offshore projects that we're working on. Some of it is, it's a lot of relationship work in Japan and we want to position ourselves with the right expertise, ability to execute and strength within the culture of Japan added to partner with.

Unknown speaker

Understood. And then moving on to Texas, do you have an update on the congestion on transmission line? And with that, could you tell us what the market prices are like...

Mike Garland -- President and Chief Executive Officer

Rupert, it's hard to hear you. Can you speak up a little bit?

Unknown speaker

Yes. So on Texas, I was wondering if you have an update on the congestion on transmission lines and with that, if you could tell us what the market prices are like over there?

Mike Garland -- President and Chief Executive Officer

Yes. On the congestion front, there's been some improvements. ERCOT changing a few of the way they manage this and ETT, in particular, has tried to adjust their schedule. It's saved us some money this year and we're hoping next year, but it's not significant.

It's a modest amount compared to the overall exposure on congestion. We're seeing some relief in panhandle area, but not enough. We think it'll be mostly resolved through the end of next year -- excuse me, this year, 2019, but it really depends on how much additional build-out there is in the area. So we're being cautiously optimistic that we're going to be able to see some improvements in the ERCOT congestion.

On market pricing, near term, the pricing has improved substantially. We're seeing -- for example, we've postponed in the repowering of Gulf Wind to be able to operate through the summer and beginning of fall because the prices have increased tremendously. I think some people were feeling that the pricing in Texas may be down in the 30s and we're seeing it more in the 50s and the 60s potentially through the summer. So things have improved on the spot market.

We think that's temporary, that it's not going to be long term. This year it certainly looks very attractive to be in the market and being able to produce during that -- the summer months in particular. And if you remember, Gulf Wind in particular has more of a peaking arrangement around its production because when it heats up, it draws more current off of the coast and produces more relative to something more like the West Texas, where during the heating period, you'll often see a reduction in production. You typically will see the opposite in the coastal areas.

So both of those things are good for us, but we're just cautious about. As you know, the market in Texas is very volatile sand both in terms of how they build things out and how they respond and the timeliness of the ERCOT response and the market. Last year, we thought there's going to be a lot more spikes and they didn't happen and so we are being conservative in how we approach this.

Unknown speaker

OK. That helps. And then finally, you touched on Gulf Wind, how conducive would you say the new turbine would be toward the PPA negotiations, assuming a lower nameplate capacity, but a high capacity factor?

Mike Garland -- President and Chief Executive Officer

I'm sorry, yes, the new turbines will produce slightly more power that we're going to be using the existing towers and so we are not putting much bigger turbine capacity, it's roughly the same megawatt capacity on it, but longer blades. And so the production is improved, but the big pickup is in the production tax credits. We will be using PTC qualified turbines so that the repowering will be receiving production tax credits, it's roughly 10 years old and so it's running out of its original PTCs and by repowering it, we regenerate a new source of revenue, if you will. That's the primary driver, not the increased capacity factor which is relatively modest.

Unknown speaker

OK. Great. That's it for me. Thank you.

Operator

Your next question comes from the line of Julien Dumoulin-Smith from Bank of America Merrill Lynch. Your line is open.

Julien Dumoulin-Smith -- Bank of America Merrill Lynch -- Analyst

Hey, good morning, everyone. So a couple of quick things. First off, I apologize if I missed this. With respect to the slight tweaks here in the definition on the cash available for distribution, can you walk through just how that impacts things? I know that there are couple gives and takes there.

Just with respect to the '18 actual and then '19 outlook, just what does that mean here? Because I noticed that despite the change, the '18 actual was still relative to the initial guidance range, so it sounds like that implies that is not too material, but I'm just curious on how you would frame that?

Mike Lyon -- Chief Financial Officer

It's not that it's not too immaterial, it's the same. We get the same result whether we use the prior definition or the new definition and the new Reg G Reconciliation, we get to the same bottom line, and that was our intention. This really arose, Julien, out of a desire to recognize though internally, we use this more as a performance measure than we do as a liquidity measure, and we felt that the change in the definition and the reconciliation more closely aligns with our philosophical thinking about this.

Mike Garland -- President and Chief Executive Officer

It's really an accounting convention whether you go one way or the other. You might get it. Some people may not be following the distinction you're making.

Mike Lyon -- Chief Financial Officer

So this goes to the question of whether the non-GAAP measure is a liquidity measure or a performance measure under SEC characterizations, and we've concluded increasingly that it is a performance measure and as a result, again, under rules, we should be reconciling to its nearest GAAP performance measure, which is net income rather than its nearest GAAP liquidity measure, which previously was net cash provided by operating cash activities as shown in our cash flow statement. So I think it's a somewhat inconsequential change, but it's one that we needed to highlight and explain, which we've done in the 10-K that will be filed later today.

Julien Dumoulin-Smith -- Bank of America Merrill Lynch -- Analyst

Got it. Understood. And so just, again, it's not just '18, but '19 and '20 would also be inconsequential or the same, just to be clear on that?

Mike Lyon -- Chief Financial Officer

They'll be the same, whether we use the old method or the new method, and we presented historical results under our new calculation approach, and they are the same as the results under the old computational approach.

Julien Dumoulin-Smith -- Bank of America Merrill Lynch -- Analyst

Excellent. Then I just -- sorry to jump back to this. I know it's been kind of picked apart a little bit more, but on the '19 to '20 walk, excellent for providing it, but with respect to the new investments, can you pick that apart a little bit further just the $15 million and then just to make sure I'm hearing you right on the pattern distributions from the 2.0 structure, is that a firm statement from you that you guys are expecting cash distribution? I just want to make sure I'm hearing you right. Because I know that there was a little bit ambiguity in the last call about that, but just want to make sure I understand it.

Mike Lyon -- Chief Financial Officer

Right. So the $15 million is really based on an expectation that we will acquire new assets from the iROFO list, and that we'll use capital that we derive from one or more of the sources that we outlined in the call. I think one of the most likely ones is something we've talked about a number of times in the past year or so, which is the recapitalization of our Japan business to uncap attractively priced equity capital in the Japanese market. But there are other sources that are available to us, which we may cap either this year or early next year and that includes, as a couple of examples, a hybrid type of capital for a balance sheet and the second would be further asset recycling.

So this is based on assets that we expect to be available that we can use one of these sources to generate incremental cash flows.

Mike Garland -- President and Chief Executive Officer

Yes. Actually, the way I think about it, and Mike may kick me front of the table, but if you think about the new investments of $15 million to CAFD improvement in 2020 and $5 million in 2019, that's a total of $20 million. If you use our rule of thumb of 10x, that's $200 million of investment to get $20 million of CAFD during those two periods of time. That's a very modest amount of megawatts we need, if you look at $200 million of investment against our iROFO list of 1.4 gigawatts.

And so I think that's to me the best indicator that we're being -- if we have additional sources of capital, we could do even more on, but it's a very modest assumption in terms of the amount of capital that we're actually investing to -- relative to the iROFO list.

Julien Dumoulin-Smith -- Bank of America Merrill Lynch -- Analyst

But to be clear about that just go for it.

Mike Lyon -- Chief Financial Officer

I was going to answer your second question, but sounds like you want a clarification on the first one so...

Julien Dumoulin-Smith -- Bank of America Merrill Lynch -- Analyst

Is that $15 million and $5 million, is that a net number or a gross number? I mean net of incremental interest expense, etc.? It sounds like that's a smaller piece of it.

Mike Lyon -- Chief Financial Officer

Julien, those are net numbers after accounting for some carrying charges.

Julien Dumoulin-Smith -- Bank of America Merrill Lynch -- Analyst

And then the second part, sorry, with the distributions, the...

Mike Lyon -- Chief Financial Officer

Pattern Development 2. Yes, look this is a range that we're confident in being able to deliver on. Is it a guaranteed expectation, is it a contracted cash flow expectation? No. But we believe the business plan supports a expectation within this range or better, and we're confident in our ability to deliver it next year.

Julien Dumoulin-Smith -- Bank of America Merrill Lynch -- Analyst

Got it. Last quick one on the bridges assumed for distributions in '19 and '20?

Mike Lyon -- Chief Financial Officer

Yes. We continue to be paid by PGD. We had a very small amount of -- very small exposure, but they're paying us current, and we would anticipate that that will continue. I would also note that it's very small part of our project portfolio.

Mike Garland -- President and Chief Executive Officer

Yes, Mike. I think and the anticipation is that they're going to suspend payments going forward during the bankruptcy process, and it's going to be still owed, but they're acting like they may be not making current payments on. And like Mike said, it's a very modest amount of money for us relative to the overall cash flow of the business.

Julien Dumoulin-Smith -- Bank of America Merrill Lynch -- Analyst

Got it. But your anticipation is that they might accrue certain amounts during the process whatever?

Mike Garland -- President and Chief Executive Officer

Yes.

Julien Dumoulin-Smith -- Bank of America Merrill Lynch -- Analyst

All right. Excellent. OK. Thank you very much for the details.

Operator

Your last question goes to the line of Colin Rusch from Oppenheimer. Your line is open.

Colin Rusch -- Oppenheimer and Company -- Analyst

Thanks so much, guys, for all the details today. I'll be a little bit quick, but this maybe a naive question. But is there anything where provides an opportunity for you guys or do you have any agency in terms of mitigating some of the exposure in ERCOT? Just curious if there's maybe an opportunity for you to augment some of your assets to help support that network in the near term?

Mike Garland -- President and Chief Executive Officer

I'm sorry. Ask the question again? Are you saying providing third-party services in the ERCOT area?

Colin Rusch -- Oppenheimer and Company -- Analyst

Honestly, it's really about is there an option for you to integrate some energy storage and supplement some of the income or mitigate some of the losses there.

Mike Garland -- President and Chief Executive Officer

Yes. We're looking at a whole bunch of stuff. Our guys have analyzed even putting in a private transmission line we talked about. I think we're seeing some improvement in just how people are bidding and acting in the Panhandle area, where there seems to be a lot more realization that it's not a good idea for everybody to bid as much as they can at the lowest price, and so we've seen a little firming out there.

But the three things that we have looked at are putting energy storage in, putting transmission line and that would service not just us, but everybody, and then we have a third option that we look at of taking over another project, which would give us a different path to evacuate power and into a different market. And there's some other things that we're looking at as well. None of them are overwhelmingly cost effective right now, but we're evaluating the benefit and the timing of it.

Colin Rusch -- Oppenheimer and Company -- Analyst

Thanks so much.

Operator

There are no further questions at this time. I turn the call back over to the presenters.

Mike Garland -- President and Chief Executive Officer

All right. Well, thank you, everyone, for joining the call today and as always, feel free to give us a call if you have further questions, and we're looking forward to 2019. Thank you very much.

Operator

[Operator signoff]

Duration: 63 minutes

Call Participants:

Mike Garland -- President and Chief Executive Officer

Mike Lyon -- Chief Financial Officer

Brian Lee -- Goldman Sachs -- Analyst

Ben Pham -- BMO Capital Markets -- Analsyt

Julien Dumoulin-Smith -- Bank of America Merrill Lynch -- Analyst

Colin Rusch -- Oppenheimer and Company -- Analyst

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