22 Jul 09 Eddie's Blog Global

Risk reducing aspects of wind energy

Why the risk reducing aspects of wind energy are not more widely appreciated.

The electricity industry is a rum industry (to use an old fashioned adjective). It is the only one I know where an important, even dominant, risk as we understand it in business is mitigated by the electricity regulatory and competitive system.

When the price of fossil fuels goes up, all hell breaks loose in the airline industry. Companies go to the wall, average profits plummet, and customer service suffers. Every other private sector industry is impacted by volatility in the price of fossil fuels. Three of the last four recessions were caused by fossil fuel price hikes. (Maybe the last one was as well only it was masked by the banking collapse).

Here is the question. When did you hear of an electricity utility that stuck to its home market getting into financial trouble? As a model it works beautifully, most of the time. Pension funds invest in a low risk utility, the costs of capital are almost as low as sovereign debt. The concept of a customer exists only vaguely, nearly every consumer would not be able to tell the price they pay per unit of electricity. Although markets are opening slowly, and some customer churn is evident, by and large the utility remains monopolistic in practice. Some parts of a utility’s service are indeed logically monopolistic. The transmission grid is a singular industry, a natural monopoly. No one wants or needs two sets of power lines running across the state, competing with one another. The only question is whether this monopoly should be in private, part private or public ownership.

Electricity is quite cheap as an energy source. It is also incredibly flexible. It is convenient to a degree that no other energy source comes even close. It is so necessary that it is a huge political issue. I don’t believe that any government in a country, used to having it, could survive a serious and sustained lack of the basic electricity commodity.

Due to these considerations the average electricity utility is a protected species. Governments don’t let them fail. (We will deal with the exceptions below). When the price of fossil fuels goes up the price of electricity goes up to allow the utility to make the same economic returns. The Regulator, or the PUC, or the Government Department always allow the price increase. In this way the utility is insulated from fossil fired price risk.

I am not seeking to cast aspersions, to lay blame, or to denounce this behaviour. We exist to describe the facts as they are. If I was in Government, and I had become accustomed to seeing a steady price for oil of between $12 and $18 per barrel for a period of 20 years, I’m sure I would have been happy to acquiesce in a situation where the utility became an integral part of the Government service. I would have been happy for the utility not to have taken any risks, not to have encouraged innovation, and to in fact see it as part of the civil service.

I mentioned exceptions above. Some countries encourage private sector behaviour as an article of faith. The US has a largely privately owned utility sector. Many of these companies have ventured outside their home patch. The ones who came to the UK when it opened its electricity market, got wiped out financially when the British changed the system, from the pool to NETA.

However if the utility sticks to it’s last, it stays in business. It is not subject to what would normally be it’s biggest risk: fossil fuel price increases.

This fact gives a clue as to why the average utility has not embraced wind energy with any enthusiasm.

The greatest aspects of wind and solar is that the price is fixed, and that the marginal cost is zero.

Fixed price: the cost of wind or solar is the cost of developing and building the wind fired power station. It is predictable over any time horizon. It is completely un-correlated to the price of fossil fuels. If wind energy were a financial product it would resemble a Government bond. Low yield but absolutely reliable. And just as a government bond in a portfolio of stocks and shares enhances the yield by lowering the risk, wind energy reduces the cost of electricity by reducing the fossil fired price risks. This has been shown in study after study. The latest is in a study conducted by Dr. Shimon Awerbuch into the Scottish electricity system. There he showed that raising the wind energy contribution from 21% to 32% lowered the price by 6%.

Why do utilities not value this? Because they can pass on the risk of fossil fuel price increases to “consumers”.

Let me try and put this more graphically. Fossil prices double. The utility goes into the regulator and explains the price rise. The regulator sanctions a price rise in the cost of electricity. The regulator does not ask “how much wind or solar have you installed on the system to mitigate these price increases, which by the way you know are inevitable”?

Our next blog will show how Renewable Energy Feed In Tariffs (REFIT) pay for themselves usually from year one.