16 Jul 09 Eddie's Blog United States

Examination of the US Renewable Energy market

Well folks, I have been out of the country on a world tour for the last four weeks, I welcome this opportunity to catch up on the latest big issues.

As far as renewable energy is concerned nothing could be bigger than almost the total failure of the US and Canadian markets throughout 2009. Anecdotally, announced sales of wind turbines in the first half of 2009 in North America have fallen to 3% of the 2008 levels. Although very extreme, this is not the first time we have seen such a sharp decline nor is America the only market to have experienced it.

The Danes abolished support programmes some years ago resulting in hardly any on land wind energy development in Denmark since.

Examination of the US market is instructive because of the way it is attempting to introduce a sustainable, native, free fuel source.

In the 80’s the US had an Investment Tax Credit, however the main shortfall with this programme was a lack of long-term incentive. If and when turbines suffered mechanical failure through ongoing wear and tear there was no incentive to get them running again; as the investors had received their payout and in many cases were now far removed from the projects.

Throughout the 90’s there was a prolonged slump. Since 2000 or thereabouts, onshore wind has been supported by the production tax credit (PTC) system. This system in essence is a transfer of resources from the American tax payer to the electricity industry. It lowers the overall cost of electricity. It has however some famous drawbacks. It required frequent renewals often by an Act of Congress, which led to booms and slumps in the industry. It has to be said it is a reasonably popular item and so it becomes a political football; a source of “pork” if you like.

The PTC has of course two further drawbacks which are:

1. The people who make use of the PTC must have a line of sight to long terms profits. They were generally the big banks, so the current banking crisis has done away with the PTC as a source of support for renewables.
2. Renewables are forced to compete with fossil fuels. They are subjected to a market regimen which sees them compete with the marginal cost of electricity. The marginal cost in most States is driven by gas. Gas has been selling for less than $4/million Btus. Even with the PTC scheme, wind is unable to compete. So renewables developers, manufactures, consultants and support service providers (building contractors, wind analysts, lawyers, financiers) are in effect forced to take fossil fuel risk.

This, we are uniquely unsuited to.

The whole renewable industry in the US is subjected to three levels of risk:

1. Political risk;
2. Banking health risk;
3. Fossil fired price risk.

In time renewable energy, mainly wind and solar will replace fossils as the primary energy input into making electricity. So severe is the crisis in fossil supply that we see the price move from $60 to $147 to $32, to $72 and back to $60 in the space of eighteen months.

This volatility is both the measure of the tight supply/demand situation and of the risks that are incurred by any industry that is linked to fossil fuels.

Of course, wind and solar, both in quantity and price are completely independent of fossil fuels. There is zero correlation between them. The lack of correlation leads to the following important result for the electricity industry.

Risk Reduction Effect of Wind:
In a generation portfolio that is comprised of mainly coal, oil, gas or nuclear, wind and solar act as strong risk mitigants. In a study carried out by the late Dr Shimon Awerbuch in Scotland, he demonstrated that if the amount of wind on the system went from 21% to 32% and the systemic risk was held constant, then the price of electricity would have dropped by 6%.

Replacement Energy Effect:
In another study this time of the Mexican economy, Dr. Awerbuch showed how deploying 10% wind on the Mexican system would reduce the price of fossil fuels by 9%. This effect has been observed many times in Europe, particularly in Northern Europe where Germany has 22,000 MWs of wind plants installed and Denmark has 3,700. So in fact wind on the system reduces the price of electricity generated from fossil fuels.

Merit Order Effect:
There is a third effect called the merit order effect. The effect is caused by the variable price of wind being precisely zero. When wind is blowing it is dispatched first and it replaces the higher cost generating plants. Wind does not replace the average efficiency plant on the system but the least efficient highest cost generating units.

Carbon Reduction Effect:
Wind generated electricity is carbon free, no carbon fines will ever apply to wind energy.

Amounts of energy production and associated pricing for wind and solar generated electricity can be predicted with great accuracy over 6, 15, even 30 years; this provides a long term (and indeed short term) risk reducing effect. Predictable production gives us a clue as to what the most appropriate support mechanism for renewables: a fixed price feed in tariff or Renewable Energy Feed in Tariff (REFIT). In the three European countries which have made the greatest progress with onshore wind, Denmark, Germany and Spain, a REFIT system has been employed. Since initiation of the programmes it has been discovered that the REFIT programme is only required for ten years. Thereafter renewables can stand on their own and trade on the system at whatever price the market dictates.

A renewable energy feed in tariff – the “REFIT” is appropriate because it reflects two attributes of renewable energy:

· The price is fixed, in fact is set by the capital cost of installation,
· It reduces the overall electricity pricing risk on the system which is created by fossil fired price variability.

A REFIT system cuts out the booms and slumps that are experienced using tax based incentive programmes. It keeps the payment for renewable energy within the electricity system. The value of wind can be calculated without having to take into account wider aspects such as general taxation. It is safe to say that if a REFIT system had been introduced in the Year 2000, America could have between 5 and 10% of its electricity now coming from wind.

Every thousand MWs of wind on the electrical system would forego the importation of 3.9 million barrels of oil. At a price of $60 a barrel, this would forego spending of $235m per annum. The wind was, is, and always will be a free source of primary energy.

At these levels the US would probably be employing an extra 100,000 people and would be well on its way to energy independence. In effect the first tranche of MWs built in the year 2000 would be coming out of REFIT support in the year 2010 (next year).

Such wind fired generation would be used by a typical utility in one or both of two ways:

1. To outcompete the utility with less wind and,
2. To mitigate this fossil fired price variability and make more profits and higher value for its owner.

So what do energy consumers need? The same things that wind needs:

· A stable mechanism which will create pricing confidence and eliminate boom slump cycles in the industry;
· A stable mechanism that provides downward pressure on our electricity prices;
· A stable mechanism that encourages renewable developments which will reduce fossil fired generation and all of its associated problems
· We need Renewable Energy Feed in Tariff programmes instituted in every jurisdiction.

One note of encouragement can be taken from the actions of the Province of Ontario, Canada. They are currently in the final stages of implementing a feed in tariff programme known as “the FIT Programme”, contained within their Green Energy Act. It is the first of its kind in North America, is modelled after successful European examples; we are watching its development quite closely and are very encouraged by the efforts of this government.