The Town of Breezyville is considering initiating a wind power project to provide electricity

| August 30, 2017

Question
Background

The Town of Breezyville is considering initiating a wind power project to provide electricity to its residents. The wind power project will be located on the outskirts of Breezyville. The project is being considered for both its economic and environmental benefits. The key question that the Town of Breezyville is trying to address is: does the wind power project make sense from an environmental and economic sense?

Below is some of the information that the Town has collected to estimate the benefits and costs of the proposed wind power project. In this case examined here, we assume a single turbine, 1.5 Megawatt (MW) project. The site being considered has strong, predictable winds that make it a good candidate for a wind power project. It is assumed that the Breezyville wind power project will operate 33% of the time based upon the availability of wind. All monetary values used in this exercise are in real $2012 dollars.

Capital Costs

Wind project costs are a function of many variables, but not limited to, project size, ownership structure, location and characteristics of a particular site, turbine and turbine manufacture, exchanges rates (i.e., if a foreign turbine is used) and even commodity costs (i.e., the cost of steel). For this exercise, some simplifying assumptions have been made. It is estimated that the capital costs of the Breezyville wind power project can be divided into four components: the turbine purchase, construction costs to install the turbine, costs to connect the turbine to the local electricity grind, and “soft” costs such as legal fees, engineering and siting plans etc. In total, the cost of installing the wind turbine is roughly $1,880,000 in the first year of the project. Assume for this exercise for simplicity, that the capital costs are a one-time expense that occurs in the first year of the project.

Operating Costs

The operating costs of the Breezyville wind power project include a variety of components such as operations and maintenance of the wind turbine, repair costs, management and administrative costs, property taxes, the costs to lease the land and insurance. Operating costs are estimates at roughly $87,000 annually. The wind power project is anticipated to operate for twenty years. Annual operating costs for this exercise are assumed to be constant though time.

Scrappage Value

At the end of its useful life (i.e., 20 years), it is anticipated that the wind turbine can be sold at roughly $100,000. This is the scrappage value of the wind power project in twenty years.

Electricity Price

Once the Breezyville wind power project is up (i.e., in the first year) and running it will produce electricity that can sold into the existing electricity grid. The price of electricity in Breezyville is $0.07/ kilowatt-hour.

Avoided Climate Damages and U.S. Government Tax Credit

The wind power project will produce no carbon dioxide, a greenhouse gas that contributes to global warming. Thus, the Breezyville wind power project will avoid climate related environmental damages. For this exercise, it is assumed that if the wind power project had not been built that electricity produced from diesel power would have been used instead to produce electricity for the Breezyville residents. The diesel electricity plant would have produce climate damages of roughly $0.04/kilowatt hour (assuming that CO2reductions are valued at roughly $50/ton). (The “horizon” value for C02is captured in the $0.04/kilowatt hour estimate. Thus, for this exercise assume that the “horizon” value for C02is zero).

Also, to help finance and spur wind projects across the country, the U.S. government is providing a renewable wind tax credit of $0.04/ kilowatt-hour to help promote the use of wind power. The tax credit is assumed to extend throughout the 20 years of the wind power project lifetime.

Key Assumptions

For this exercise assume that:

1 Megawatt (Mw) = 1000 Kilowatts (Kw)

1 Mw x 24 hours x 365 days (full capacity) = 8760 Megawatt hours (Mwh)

Part Two

(1)Sensitivity One: Instead of a 20-year lifetime the wind turbine, assume that the wind turbine has a lifetime of 10 years. Assume also that there is no scrappage value for the wind turbine at the end of its useful life (i.e., 10 years). What is the net present value of the wind project with a 3% and 7% discount rate with a 10-year useful life for the wind project? What is the estimate of the internal rate of return with a 10-year useful life for the wind project?

Hint: Assume for this sensitivity that the tax credit is a transfer payment from the federal government to Breezyville to help incentivize wind power. Since the payment “nets out” between the federal government and Breezyville, it is not considered a social benefit for purposes of this sensitivity.

(2)Sensitivity Two: Assume that the amount of wind power in Breezyville is overestimated and that the capacity factor of the wind power project is only 16%. Assume a 20-year lifetime for the wind project, a scrappage value of $100,000 at the end of 20 years and that the Federal wind tax credit remains in place at $0.04/kwh. What is the net present value of the wind project with a 3% and 7% discount rate with the lower capacity factor? What is the estimate of the internal rate of return with the lower capacity factor?

Hint: For this sensitivity, assume that the tax credit is a transfer payment from the federal government to Breezyville to help incentivize wind power. Since the payment “nets out” between the federal government and Breezyville, it is not considered a social benefit for purposes of this sensitivity.

(3)Sensitivity Three: For this sensitivity, assume that Breezyville is just looking at financial costs and benefits that the Town incurs/receives from the wind power project. In other words, the Town of Breezyville doesn’t consider the climate benefits of the project. Also, assume that because of budget pressures, the Federal wind tax credit ($0.04/kwh) is eliminated. Continue to assume that the wind turbine has a useful life of 20 years, and that the scrappage value of the project at the end of 20 years is $100,000 and that the capacity factor for the wind power project is 33%.

What is the net present value of the wind project with a 3% and 7% discount rate from the Town’s perspective in this sensitivity? What is the estimated internal rate of return from the Town’s perspective in this sensitivity?

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