Price is not the only economic variable to consider in deciding what kind of generation a utility should build. Different kinds of power have different risks associated with them. This is important even if we set aside for the moment the climate risk associated with fossil fuels (e.g. the risk that Miami is going to sink beneath the waves forever within the lifetime of some people now reading this). It’s true even if we ignore the public health consequences of extracting and burning coal and natural gas. As former Colorado PUC chair Ron Binz has pointed out, risk should be an important variable in our planning decisions even within a purely financial, capitalistic framing of the utility resource planning process.
Utility financial risk comes largely from future fuel price uncertainty. Most utility resource planning decisions are made on the basis of expected future prices, without too much thought given to how well constrained those prices are. This is problematic, because building a new power plant is a long-term commitment to buying fuel, and while the guaranteed profits from building the plant go to the utility, the fuel bill goes to the customers. There’s a split incentive between a utility making a long-term commitment to buying fuel, and the customers that end up actually paying for it. Most PUCs also seem to assume that utility customers are pretty risk-tolerant — that we don’t have much desire to insulate ourselves from future fuel price fluctuations. It’s not clear to me how they justify this assumption.
What would happen if we forced the utilities to internalize fuel price risks? The textbook approach to managing financial risk from variable commodity prices is hedging, often with futures contracts (for an intro to futures check out this series on Khan Academy), but they only work as long as there are parties willing to take both sides of the bet. In theory producers want to protect themselves from falling prices, and consumers want to protect themselves from rising prices. Mark Bolinger at Lawrence Berkeley National Labs took a look at all this in a paper I just came across, entitled Wind Power as a Cost-effective Long-term Hedge Against Natural Gas Prices. He found that more than a couple of years into the future and the liquidity of the natural gas futures market dries up. In theory you could hedge 10 years out on the NYMEX exchange, but basically nobody does. Even at 2 years it’s slim!
I just finished reading Renewable Energy Policy by Paul Komor (2004). It’s a little book, giving a simplified overview of the electricity industry in the US and Europe, and the ways in which various jurisdictions have attempted to incentivize the development of renewable electricity generation. The book’s not that old, but the renewable energy industry has changed dramatically in the last decade, so it seems due for an update. There’s an order of magnitude more capacity built out now than ten years ago. Costs have dropped significantly for PV, but not for wind (according to this LBNL report and the associated slides). We’ve got a much longer baseline on which to evaluate the feed-in tariffs and renewable portfolio standards being used in EU member countries and US states. I wonder if any of his conclusions or preferences have been altered as a result? In particular, Komor is clearly not a fan of feed-in tariffs, suggesting that while they are effective, they are not efficient — i.e. you end up paying a higher than necessary price for the renewable capacity that gets built. This German report suggests otherwise, based on the costs of wind capacity built across Europe. Are the Germans just biased toward feed-in tariffs because they’ve committed so many resources to them? NREL also seems to be relatively supportive of feed-in tariff based policies, but maybe this is because the design of such policies has advanced in the last decade, better accounting for declines in the cost of renewables over time, and differentiating between resources of different quality and utility.
Lawrence Berkeley National Labs has put out a report on the state of the wind energy industry, as of the end of 2011. I didn’t realize that the price trend had been so uneven over the last decade. The cost of wind power was dropping in the early 2000s, and then rebounded, peaking in 2008/2009 due to shortages in the turbine supply chain, before again dropping in the last year or two. I started looking into these prices because I’m reading a Renewable Energy Policy by Paul Komor (2004) and the prices he quotes ($40-$50/MWh) seem low, relative to the numbers from Xcel’s ERP and the recent bids I saw in Michigan (more like $60/MWh), but the book was written right at the wind price bottom. I’m also shocked at how wide the spread in costs is, even in just the last couple of years. California is paying $100/MWh for huge projects, and in the wind belt some projects are coming in more like $25/MWh. That’s got to be largely policy driven, and it indicates we’ve got a woefully inefficient market for wind.
When people compare the cost of gas-fired electricity and renewables, they usually don’t price fuel cost risks, and at this point that’s really just not intellectually honest. Risk-adjusted price comparisons are very difficult because nobody will sell a 30 year fixed price gas supply contract, and that’s what you’d need to buy to actually know how much your gas-fired electricity will cost. Even a 10 year futures contract doubles or triples the cost of gas. You can’t buy renewables without their intrinsic fuel-price hedge, and that hedge is valuable. The question shouldn’t be “Is wind the absolute cheapest option right now?” it should be “Given that wind will cost $60/MWh, are we willing to live with that energy cost in order not to have to worry about future price fluctuations?” And I think the answer should clearly be yes, even before you start pricing carbon.
Vaclav Smil on the the scale and difficulty of executing an energy transition for the civilization. “Calculate with me!” he says, before diving into a bunch of order-of-magnitude demonstrations that this is all much harder than we might like to think. He’s very pessimistic about the large-scale integration of intermittent resources, and also about humanity’s ability to initiate a change voluntarily. Would like to understand those positions better… and still continue to disagree with them. The talk is long and rambling, but he’s so clearly engaged and emphatic that it doesn’t matter.
In the 2011 annual report to the state legislature on the cost effectiveness of Michigan’s Renewable Energy standard, it was revealed that wind bids have been coming in far cheaper than anyone expected they would. In fact, even without the federal production tax credits, they’re far cheaper than new coal fired generation ($61/MWh for wind vs. $107-133/MWh for new coal). Interestingly, Xcel’s 2011 resource plan lists the cheapest new generation option in Colorado as being natural gas combustion turbines… at $60/MWh. So wind is cheap. It’s also very low risk. So how do we get more of it?
It’s often been said that “time is money,” and it turns out to be more than an aphorism.
I’m going to try and tell you a story about discounting, which is one of the ways that we convert between time and money. The story has broad implications for the energy investments we choose. It’s not entirely straightforward, and if it’s going to make sense there are some background pieces you’re going to need. The background is important because the ending depends not only on understanding what is being done, but why. This story happens to be about Xcel Energy and Colorado, but the same thing happens in other places, with other companies, and in other contexts too.
To greens my argument may seem circumspect. I’m not going to challenge the doctrine of Everlasting Economic Growth. I’m not going to look at the large externalized costs of burning fossil fuels. I’m not going to argue against the monopoly electrical utility model. Those are important discussions to have — they’re just not the one I’m having here. What I’m trying to do is show that a minor change in the way we calculate the cost of future energy can drastically alter what kind of power we decide to invest in for the next century, even if we only look at the decision in selfish financial terms.
To the finance geeks among you, much of the background will be familiar, but the situation may seem strange unless you’re familiar with how regulated monopolies work. I haven’t been able to find anyone familiar with energy finance who thinks what we’re currently doing makes sense, but if you’ve got a thoughtful rebuttal, I’m genuinely interested to hear it.
Sustainable Energy, without the Hot Air by David MacKay, is a book (available in its entirety online) looking at the sources of energy available, and the ways in which we use it today. There are lots of options, but any real discussion has to, at the very least, use numbers that add up.