Tuesday, August 24, 2010

Recent Wind Leasing Activity in Arkansas

It surprised me to learn that a commercial wind generation project exists in Arkansas. David Smith gave a lengthy write up of the project in the August 22, 2010, Democrat Gazette. TradeWind Energy proposes to erect 165 foot tall wind turbines on Star Mountain in Searcy County. Why is this surprising? Based on the figures from National Renewable Energy Laboratory (NREL), Arkansas has less than spectacular potential for commercial wind generation. The data show Arkansas to have around 9,200 megawatts of capacity for turbines 80 meters above the ground with a Gross Capacity Factor of 30% or more (30% is the threshold at which commercial potential begins). This places Arkansas at about the 44% percentile among the lower 48 states. Contrast this with other states such as Texas (1,901,529 MW), Oklahoma (516,822 MW), and Kansas (952,370 MW). The potential in Arkansas is appreciably better at 160 meters above the ground. At 160 meters, Arkansas rates at about the 57th percentile with about 50,000 megawatts of capacity.

The available land area for wind development in Arkansas is about 1.34% and 7.25% at 80 and 100 meters, respectively. Contrast this to states like Nebraska and Kansas (91% and 89%, respectively at 80 meters and up) where one can put a wind turbine just about anywhere.

As for specific areas of interest in Arkansas, the average wind speed maps published by the NREL show most of the higher average wind speeds to be in the highest elevations in the state (Ouachita, Boston, and Ozark Mountains). If a wind project locates in Arkansas, it is very likely to happen in an area like Searcy County. The turbines will be very tall and on top of mountains and ridges. A company that locates in Arkansas will face large construction costs because of the difficulty in constructing on mountain and ridge tops. This cost could be offset by close proximity to transmission lines in locales with higher than average wind speeds.

Even though the potential for wind energy in Arkansas is limited, the fact there is activity merits consideration of wind leasing. With a 30% federal production tax credit for wind energy and the availability of USDA Rural Energy for America Program grants to fund up to 25% of a qualified wind project, the interest in marginal wind areas like Arkansas will continue. I will give the anatomy of a wind lease and compare it to the oil and gas lease with some considerations for landowners and their attorneys.

Much like an oil and gas lease, the wind lease has a “primary term” or upfront period where the operator assesses the potential to develop the resource. In an oil and gas lease, the operator may come upon the land to conduct seismic surveys, drill test wells, and so forth. The equivalent of the primary term in a wind lease is the “development period,” “option period,” or “option phase.” In this post, I’ll call it the “option period.” In the wind lease, the option period consists of coming upon the property to measure wind speeds over time, constructing apparatuses for measurement, and conducting necessary environmental surveys. The term “option period” is a fitting label because the operator pays for the right to investigate the site, but is under no obligation to develop the property. During the option period, the wind operator will pay base rent to the land owner for the right to “explore” the property for wind potential. Base rent is much like an oil and gas lease’s bonus or delay rental payments. If the site meets the operator’s standards, the operator will carry the lease into the next phase.

Following the option phase is the construction phase. This is a unique aspect of wind leases. The construction phase is akin to the waning hours of the oil and gas lease’s primary term where the oil and gas company must begin drilling a well. To keep the wind lease in force, the wind company must begin construction of the wind plant. This might include things like site clearing, road building, and general construction activities. This is the oil and gas equivalent of “commencing operations” and “continuous operations.” A poorly negotiated lease may not limit the construction period or provide additional money for the construction phase. If this is the case, the landowner may find his or her land encumbered by the lease with no serious prospect of royalties. A landowner friendly wind lease should provide some limit on the amount of time the operator has to construct the wind turbines and should provide additional compensation above the base rent.

Once the operator constructs the wind turbines, the lease enters the operation phase--the oil and gas lease equivalent of the secondary term--where the wind operator begins to produce electricity. This phase is sometimes called the “operation period,” “generating period,” or “generating phase.” It is in this phase where the landowner begins to collect royalties from electricity sales. In general, the royalty paid to the landowner will be the higher of the base rent or a percentage of the power sold to the grid. The operation phase should last for the life of the wind turbines or some pre-determined length of time. The operation phase will likely last decades. The landowner should obtain a fixed time limit on the operation phase along with a constraint on the useful life of the turbines such as the ability of the operator to turn a profit off power generation.

The final phase of the wind lease life cycle is the decommissioning phase. Other terms are the “termination phase,” “termination period,” “reclamation phase,” or simply “decommissioning.” Once the wind project becomes obsolete or unprofitable, the operator should remove the wind turbines and restore the site to its original condition. Under Arkansas law, an oil and gas lease carries an implied duty to restore the land to its original state after the end of the secondary term. It is very likely Arkansas Courts would impose the same implied duty on a wind operator, but it is better to obtain an express covenant in the lease itself. Also, unlike oil and gas operators who answer to the Arkansas Oil and Gas Commission (AOGC), a wind operator answers no regulatory body with regard to abandoned operations. By rule and statute, the AOGC requires financial assurance from an oil and gas well operator to plug wells and remove equipment in the event the operator becomes insolvent. Without a governing body to compel financial assurance, a landowner may find themselves with several abandoned wind turbines on their property costing hundreds of thousands of dollars to remove. A landowner should require the operator to post financial assurance to guarantee the removal of the equipment at the end of the operating phase.

A landowner friendly lease should address the problems inherent to each of the phases. The problem of surface use and damages is inherent at every phase, and the lease should provide some general provisions on compensation for surface use interference and damages. Many of the standard clauses addressing this issue in oil and gas leases are directly applicable to a wind lease. A landowner should also seek a general indemnity from the wind operator and require the wind operator to carry insurance in an amount sufficient to satisfy potential claims. Much like an oil and gas lease, the wind lease royalty clause should be carefully drafted and scrutinized. The royalty clause should address what the operator can and can’t deduct from the landowner’s royalty.

There are many challenges and rewards facing a landowner who has the prospect of a wind project on their property. Noise, aesthetic concerns, interference with communications signals, and the threat of nuisance lawsuits from neighboring landowners are a few challenges that come to mind. Landowners should also be prepared for the location of power substations and transmission facilities on their land in addition to the turbines. The rewards are also considerable. The landowner has the potential to make a “windfall” profit and the satisfaction of being part of the “green economy.” The landowner should weigh the challenges and rewards carefully, and consult with the attorney of their choice prior to signing a wind lease.

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The above represents the opinion of the author and not of any organization or group to which the author may belong. This material is general information purposes, and it is not intended to create any lawyer-client relationship. Neither the transmission nor receipt of this information is an offer to extend representation by the author. Any information, opinion, and comment provided herein should not be taken as legal advice or relied upon by the reader. The author is licensed in the state of Arkansas. Commentary on cases and law from jurisdictions where the author does not hold license to practice are for demonstrative or scholarly purposes and do not represent the author is licensed or accepts cases in the applicable jurisdiction.

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