Canada: Focus on Climate Change - March 22, 2006

Last Updated: April 11 2006

Article by Bernard Roth, Tom Pepevnak , Karim Mahmud, Miles Pittman, Joseph Palin, Kevin Scott, Philip Barton, Rich Miller, John Hurley, Claude Imbeau, Charles Spector, Sebastien Vilder, Helen Newland, Ralph Cuervo-Lorens and Ron Stuber

This issue of Focus on Climate Change reviews the record growth in the Canadian wind energy industry and the government incentives and policies which are encouraging such growth.

Background:

There is currently a development boom in the Canadian wind energy industry fuelled by support from several provincial governments and from Ottawa. The national wind energy industry has expanded from just over 300 megawatts ("MW") of installed capacity in 2003 to 683 MW at the end of 2005; making Canada the 14th largest producer of wind energy in the world. The average annual growth rate between 2000 and 2005 has been 38% and 2005 witnessed a spectacular growth rate of 54% with the addition of 239 MW of new capacity representing about $400 million of capital investment. Furthermore, the Canadian Wind Energy Association ("CanWEA") expects this rapid growth to continue as 2006 is projected to again increase installed capacity in excess of 50%. In addition to projects by companies focused exclusively on wind energy, conventional energy companies are now diversifying their asset portfolios to include renewable energy sources such as wind power.

Provincial Initiatives

Significant provincial developments since 2005 include the following:

  • February 15, 2005: SaskPower called for expressions of interest for environmentally low-impact generation projects to provide 32 MW of private generation.

  • February 25, 2005: Hydro-Québec Distribution announced that 20 year power purchase agreements representing 990 MW have been signed with Cartier Wind Energy Inc. (739.5 MW)1 and Northland Power (250.5 MW) for the purchase of wind-generated electricity.

  • June 29, 2005: NB Power invited expressions of interest for the purchase of up to 440 MW of wind energy by 2016. The deadline for submissions was December 16, 2005 and they are currently under review.

  • October 31, 2005: Hydro-Québec Distribution released a call for tenders for the purchase of 2,000 MW of wind power with a deadline for bid submissions by April 17, 2007 - the successful projects could represent between $3 and $4 billion in capital investment.

  • November 21, 2005: The Ontario government and the Ontario Power Authority announced plans to procure 955 MW of new wind energy capacity from eight projects from the following developers: EPCOR, Enbridge, Suncor2, Canadian Hydro Developers, Brascan Power Wind and Kruger Port Alma Ltd.

  • November 21, 2005: The Manitoba government and Manitoba Hydro released an invitation for expressions of interest for up to 1,000 MW of wind power projects. The deadline for submissions was January 20, 2006 - it is estimated that these projects could ultimately result in $2 billion in capital investment, $1 billion in operating expenditures and $7 billion in energy sales.

Footnotes

  1. The shares of Cartier Wind Energy Inc. are held as follows: 50% by TransCanada Corporation; 30% by Innergex II Inc.; and 20% by RES Canada.
  2. In a joint venture with EHN Windpower Canada Inc.

Wind Power Production Incentive ("WPPI"):

In addition to the provincial wind procurements described above, the WPPI program of the Federal Government has also helped to fuel the current wind boom in Canada. WPPI was first introduced in May 2002 with funding of $260 million to encourage 1,000 MW of wind development by providing an incentive of $0.01 per kWh of net wind energy generated during the wind project's first 10 operational years. The 2005 Federal Budget (the "Budget 2005") added $920 million over 15 years to the WPPI program to increase the development target to 4,000 MW. As of this month, twenty projects totaling 839 MW are either under construction or have been commissioned with funding from WPPI.

There are five key requirements for eligibility under WPPI:

  1. The wind farm must be commissioned between April 1, 2002 and April 1, 2010.
  2. The wind farm must have and maintain an independently metered interconnection with the electric grid.
  3. The wind farm must have a minimum nameplate capacity of 500 kilowatts ("kW").
  4. The wind farm must be composed of new components, including turbines, towers, generators and blades.
  5. The electricity generated from a test wind turbine installed under the Canadian Renewable and Conservation Expense provision of the Income Tax Act (Canada) (discussed below) will not be eligible for WPPI.

It is important to note that Budget 2005 also allocated $97 million over five years and $886 million over fifteen years to the Renewable Power Production Incentive to encourage the development of other forms of renewable energy, such as small hydro, biomass and landfill gas. The details of this program are currently under development.

Canadian Renewable and Conservation Expense ("CRCE"):

The Income Tax Act (Canada) (the "ITA") provides important tax advantages to companies which incur certain exploration and development expenses in wind energy projects. Other forms of renewable energy may also qualify for these tax benefits.

CRCEs are expenses associated with a project whose assets are expected to be primarily included in capital cost allowance Class 43.1 of Schedule II to the Regulations under the ITA (discussed below).

Eligible CRCE expenses relevant to wind development projects include: (i) the costs of feasibility studies (including wind resource, interconnection and environmental), (ii) the costs related to engineering and design, (iii) the costs related to site approvals and regulatory approvals, (iv) the costs of preparation and negotiation of power purchase agreements, and (v) certain site preparation costs such as the construction of a temporary access road and the clearing of land. CRCE also includes the cost acquiring and installing "test wind turbines" (discussed below). Expenses that do not qualify as CRCE are such things as (i) the costs for the acquisition of land or for the right to use land, (ii) the expenses related to administration or management, (iii) insurance premiums, and (iv) financing and interest charges.

CRCEs are included in calculating a taxpayer's Canadian Exploration Expense ("CEE"). CEE is 100% deductible on a discretionary basis and can be carried forward indefinitely for use in future years. CEE may also be renounced under a flow-through share ("FTS") agreement.

Often, a wind developer will not have sufficient revenue to gain any immediate tax benefit from such expenses. The ITA permits these developers to issue FTSs to investors and the investors are entitled to claim the deductions that would otherwise be available to such corporations.

It is important to note that with respect to the costs associated with the actual turbines, only the cost of acquiring and installing "test wind turbines" qualify as CRCE. The key criteria for test wind turbines are as follows:

  • Must have a minimum spacing of 1500 meters.
  • If the total capacity of the project is greater than 6 MW, the capacity of the test wind turbines cannot exceed 20% whereas if the total capacity is less than 6 MW, the capacity of the test wind turbines cannot exceed 33%.
  • The test period must be a minimum of 120 days before any "in-fill turbines" can be installed (the in-fill turbines are the remaining turbines for the project to reach its planned capacity).
  • The project does not share with any other project a point of interconnection to a transmission or distribution system.
  • The primary purpose of installing the test wind turbines is to test the level of electrical energy which can be produced.
  • As noted above, the wind energy generated by test wind turbines (i.e. during CRCE) is not eligible under the WPPI program for the $0.01 per kWh incentive despite recent lobbying by CanWEA.

    Class 43.1 Accelerated Depreciation

    Class 43.1 allows taxpayers to recover capital cost at an accelerated rate of 30% for certain equipment that conserve energy, including wind energy systems. Proposed Class 43.2 will increase the capital cost allowance ("CCA") rate from 30% to 50%. To be eligible for the 50% CCA rate, an asset must be acquired after February 22, 2005, and before 2012. Proposed Class 43.2 is necessary to implement Budget 2005 proposals and is intended to encourage the use of renewable and alternative energy sources. The assets eligible under Class 43.1 and the proposed Class 43.2 which are relevant to wind energy include: (i) the turbine, (ii) related generation equipment, (iii) support structures, (iv) transmission equipment and (v) related costs for engineering and design.

    Emissions Trading:

    Prior to the recent change of government in Ottawa, wind energy developers could look forward to the development of the proposed Offset System of Greenhouse Gases (the "Offset System") as greenhouse gas ("GHG") emissions trading would provide an additional source of revenue. The Offset System was released by Environment Canada in the form of a discussion paper on August 11, 2005 and was discussed in Focus on Climate Change on September 28, 2005.

    While it is uncertain whether the recently elected Federal Government will continue to implement the Offset System, the proposed system would allow wind projects to be recognized as GHG-reducing projects on the basis that wind energy displaces other electricity generation. As proposed, the projects would receive "Offset Credits" based on the generated wind energy which is assumed to displace the national GHG emissions average for electricity (in 2000, the national GHG intensity for electricity was 0.219 tonnes of carbon dioxide ("tCO2") per MWh); Offset Credits could then be sold to Canadian companies subject to emissions compliance - the "Large Final Emitters" ("LFEs"). While speculation, it is commonly understood that demand would immediately exceed supply in the GHG permit market for LFEs and such market would quickly price permits and Offset Credits at $15 per tCO2 - the ceiling set by the Federal Government for GHG compliance by LFEs. By assuming a GHG intensity of the electricity displaced by wind energy as 0.2 tCO2 per MWh, it is possible to approximate the additional revenue from Offset Credits as $3 per MWh or $0.003 per kWh of wind-generated electricity; equivalent to 30% of the revenue received from WPPI.

    Summary / Contact

    Strong provincial and Federal support for wind energy has resulted in rapid growth in the Canadian wind energy industry. FMC will continue to monitor this important progress.

    The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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