Riding on the Wind

António Mexia, CEO of Ener gias de Portugal, has no delusions of grandeur. By European standards, the Portuguese utility is, he acknowledges, “an average company.” With a $23.8 billion market capitalization, EDP is a mite compared with Europe’s biggest utility, Electricité de France, valued at $216.5 billion, according to the annual ranking published in January by Washington-based consulting firm PFC Energy. Three power companies in neighboring Spain alone sport market caps exceeding that of EDP.

But, Mexia points out, “the market structure is totally different in the U.S.,” where Lisbon-based EDP would rank in the top ten, ahead of such prominent names as American Electric Power, Constellation Energy Group and PPL Corp. And it is in the U.S. that EDP is preparing to throw its weight around. Mexia’s approach isn’t conventional, however. He wants to help propel the country into the future of alternative energy, combating global warming while rewarding shareholders.

Last July, EDP acquired Houston-based wind power developer Horizon Wind Energy for about $3 billion. That first U.S. foray — EDP operates in five European countries and Brazil — contributed to a 132 percent increase in EDP’s installed wind-turbine capacity during 2007, to 3.6 gigawatts. That ranks it fourth in the wind sector, behind Iberdrola and Acciona Energía, both of Spain, and Florida Power & Light Co.’s FPL Energy alternatives affiliate. In short order, Mexia began contemplating the next step in raising EDP’s alternative-energy profile: an IPO consisting primarily of Horizon and European wind assets, called EDP Renováveis, or EDP Renewables. The plan, spelled out in January, calls for the spin-off of a 20 to 25 percent interest, with shares to be listed on Euronext Lisbon.

“We will make a go or no-go decision in May, depending on market conditions,” says Mexia. Though the IPO climate is uncertain, Mexia believes that Renováveis will stand out as the only pure-play wind stock. Renováveis’s earnings before interest, taxes, depreciation and amortization increased 46 percent last year, to €214 million ($334 million). EDP’s ebitda rose 14 percent, to €2.63 billion, while revenues were up 6 percent, to €11.01 billion. Trading recently at just above €4, EDP’s shares had gained 3 percent year-over-year, lagging Spain’s Endesa, at 6.3 percent, and ahead of Iberdrola, at 2.5 percent.

Mexia, 50, previously CEO of Galp Energia, Gas de Portugal and Transgás, has been EDP’s chief since March 2005, after serving nine months as Portugal’s minister of Public Works, Transportation and Communications. He discussed EDP and its renewables strategy with Institutional Investor U.S. Editor Jeffrey Kutler.

How does renewable energy fit into EDP’s overall strategy?

The strategy of our company is to have below-average risk compared with other utilities. Our ebitda growth is double that of a normal utility, and much of that is due to the bet on renewables — wind and water. Europe is probably ten years ahead of the U.S. in terms of renewables development. Iberia is the second-largest market for renewables in the world, after Germany. But the fastest-growing market for renewables is going to be the U.S. The Horizon deal was therefore very important. We are now in six states and will have a presence in 13 by 2010. We intend to be part of the solution to the U.S.’s need for power-sector expansion.

What do you mean by below-average risk?

That a lot of our generation and distribution activities are regulated. When we started growing outside our home turf, we started in low-risk, regulated distribution. Now, as we go global with renewables, that is lower-risk than other strategies.

Is there a chance that oil might get cheap again, making alternatives less attractive?

This is still quite a young industry that is getting very competitive [with other forms of energy]. In this environment, I don’t see any lowering of the cost of investment in the traditional [energy] sectors. When you start recognizing the costs of CO2, or carbon offsets — a major issue in Europe that will also be a major issue in the U.S. — in the total cost of energy, renewables take on an entirely different look. Even increases in equipment costs, which are happening in the wind industry, are smaller than in other energy sectors. Costs in some renewable energy technologies are expected to fall between now and 2020. Wind is the new kid in town and will play a major role in extending energy while preserving the environment.

Does wind have advantages other than economic?

The relationship between power and the environment — the climate change issue — is here to stay. It is a question of how hard and how quickly we need to move. Wind is by far the best way to move forward. The technology is more mature than solar. And in the U.S., half the country has very good load factors — there are many sites where load factors are easily 40 percent, meaning that wind is blowing 40 percent of the time. That compares with 26 to 28 percent in Europe.

How long is your history with wind, as opposed to, say, hydroelectricity?

We have more than 50 years of experience with hydro in Portugal. Wind is new all around. Fifteen years ago, many people were suspicious about the potential of wind. Only in the past five years have we seen major change in the industry. Efficiencies were gained through better equipment. Just to give you some idea, our company went from 40 megawatts of wind generation capacity in 2002 to 3.6 gigawatts at the end of 2007. We are probably the fastest-growing player in the world.

Do you consider your European experience an advantage?

We are certainly very focused on renewables and well ahead of the U.S.: Forty-five percent of Portugal’s electricity is based on renewables. We are also coming from a much more regulated market. In the U.S. you have various programs affecting this market, and some vary by state and region, such as RPS, or renewable portfolio standards, for compliance with green energy rules; PTC, or production tax credits; MACRS, the modified accelerated cost recovery system for accelerated asset depreciation; and RECs, or the renewable energy credits that you get from carbon reduction. It’s a complex picture, but the trend is clear: 27 states have an RPS scheme, more than double in four years.

Do you view the political environment as favorable?

Everybody recognizes the importance of the climate change issue, but the degree of urgency is not uniform among the states, regions or political decision makers. But all of the presidential candidates say clean energy is a priority. I see this as a low risk for our investment case, not only because the trend is toward renewables, but also because the quasiregulated nature of the market creates opportunities. The conditions for growth are very good, and as fast as the wind market is growing, it will still account for only 3 percent of energy generation in 2015, so there is great potential. Our goal is to have a 12 percent share of the U.S. wind market by 2010. And as a company, we want three quarters of our installed generation capacity by 2012–’13 to be CO2-free.

How close is EDP to those goals?

Our U.S. share is 6 to 7 percent, and we were 58 percent CO2-free at the end of 2007.

Are there gaps in the technology you need to bring wind power to full maturity?

In Europe it is possible to replace machines that were producing 0.4 megawatts with 2.5 megawatt capacity. It’s an enormous revolution — especially in a country like the U.S., where wind should naturally be part of the answer. There will be improvements in efficiency and equipment life, which would be expected of a young industry, but many technical issues are already solved. Storage is the key issue, but that is true for any type of energy other than oil or coal. The best way to store wind is water, through pumping. We are considering underground storage, using the wind to compress air at night to move turbines during the day. We are at the front line of research into these methods. Longer term, we are looking at the question of how you connect renewables with the production of hydrogen — using electricity generated by renewable energy to create electrolysis and take hydrogen out of water. Then you can store the energy in hydrogen. Wind operations — not the storage — are quite mature today, certainly ahead of solar. It will get more competitive through efficiency of machines and blades, and because other industries will get more expensive because of CO2. Our main problem today, which we don’t have with conventional technologies, is that when it comes to wind, there is no on-off button.