The Hedge Value of Renewable Energy

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The Hedge Value of Renewable Energy

• Ryan H. Wiser
• Lawrence Berkeley National Laboratory
• RHWiser_at_lbl.gov (510-486-5474)
• http//eetd.lbl.gov/ea/EMS/
• NREL Energy Analysis Forum
• Golden, Colorado
• November 9, 2004

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Motivation - To Enhance the Economic Value
Proposition of Renewable Energy
Renewable energy (RE) has attributes that can
decrease certain electricity-sector portfolio
risks

• Historically RE has been supported by policy
  and green marketing, with some vague connection
  to risk reduction benefits
• Now It is possible to make the case for RE on
  economic grounds, by quantifying risk reduction
  benefits
• Declining cost of renewables
• Increased wholesale price volatility (electricity
  and gas)
• Application of risk analysis and portfolio
  theory

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The Hedge Value of Renewable Energy

• This presentation emphasizes the benefit of RE in
  reducing natural gas price risk, focusing on
  recent research by LBNL, and ends with a summary
  of additional research needs
• Renewable energy (RE) provides a hedge against
  volatile and escalating natural gas prices in two
  ways
• Mitigates Fuel Price Risk Unlike
  natural-gas-fired electricity generation, the
  cost of RE is not tied to the cost of natural gas
• Reduces Natural Gas Prices Increased RE reduces
  gas demand, and may consequently put downward
  pressure on gas prices

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Mitigating Fuel Price Risk

• Developing a base-case gas price forecast
• Analyzing uncertainty in the base-case gas price
  forecast
• Making cost-risk tradeoffs

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Developing a Base-Case Gas Price Forecast Its
Not Easy!
Base-Case Gas Price Forecasts Vary Substantially
Across Western IRPs
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Developing a Base-Case Gas Price Forecast Make
Sure the Forecast Is Recent Because Expectations
Are Changing

• EIAs AEO Reference Case Forecasts Have Risen
  Consistently and Significantly Over Last 7 Years

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Benchmark Near-Term Gas Prices to NYMEX, which
Arguably Represents Markets Best Forecast of
Prices
Over last 4 years, forward gas prices have
exceeded EIA reference case forecasts gas price
forecasts used by some utilities have also
differed from 6-year NYMEX forward curve Use of
gas price forecasts (rather than forwards) over
this time period may have biased investment
decisions towards variable-price gas-fired
generation, and away from renewable energy When
possible, use forward prices, not price
forecasts, when comparing the levelized costs of
gas-fired and RE generation
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Analyzing Uncertainty in the Base-Case Gas Price
Forecast
Do Not Place Great Emphasis on the Base-Case
Price Forecast!!!
National Petroleum Council (2003)
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Future Gas Prices are Highly Uncertain, and
Forecasting Performance to Date Has Been Dismal
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Analysis Techniques for Evaluating Price
Variability, and the Value of Different Resource
Portfolios, Vary
Analysis Techniques to Evaluate Price Variability
and Value of Renewable Energy in Reducing Fuel
Price Risk Have Improved, but Their
Implementation is Uneven
Scenario analysis with more realistic assessment
of probability of alternative futures
Deterministic analysis with only one gas-price
forecast
Scenario analysis with focus on base-case
forecast
Stochastic/ simulation analysis

• Analytic Studies of the Costs and Benefits RE
  Deployment (e.g., national RPS, state renewable
  energy development, EERE RD benefits analysis)
• Have not begun to regularly use sophisticated
  analysis techniques
• Optimizing for least-cost in deterministic
  framework, with limited scenario analysis

• Utility Integrated Resource Plans
• Increasingly using more sophisticated techniques
  (stochastic and scenario analysis)
• Wind increasingly viewed as an important part of
  a least-cost/low-risk portfolio

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Making Cost-Risk Tradeoffs

• Utilities are beginning to conduct sophisticated
  analysis of cost-risk tradeoffs, and selecting
  wind as part of the selected portfolio
• Little work conducted so far on how to
  appropriately make the tradeoff
• Little guidance from regulators or customers on
  risk management goals and expectations
• Can further research help answer this question?
• Should risk-adjusted discount rates be
  considered?
• Should customers be given a choice of portfolios
  with different risk profiles, including a
  lower-risk green power option?

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Reducing Natural Gas Prices
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The Impact of RE on Natural Gas Prices

• Increasing number of studies show that increased
  RE will reduce natural gas demand, placing
  downward pressure on gas prices
• While this price reduction is not strictly a gain
  in net social welfare, the effect is found to
  potentially be sizable enough to merit attention
• Recent LBNL research has sought to
• Review economic theory to better understand the
  impact of natural gas demand reduction on natural
  gas prices
• Review previous modeling studies that have
  evaluated this effect, illustrating potential
  impacts of RE on reducing natural gas prices and
  consumer energy bills
• Compare the results of various modeling studies
  to each other, and to the economics literature,
  to test for consistency over time, across models,
  and with economic theory
• Determine whether existing models are treating
  this effect within reason, focusing on national
  impacts (regional impact analysis to come later)
• Develop a simplified method for estimating the
  impact of RE investments on natural gas prices,
  without using a complex, integrated national
  energy model

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Key Findings of Our Review
Models suggest that 1 drop in gas demand could
lead to 0.75 2.5 reduction in long-term
wellhead prices, with some models predicting
larger effects

• Many uncertainties remain, but central tendency
  of NEMS output is consistent with limited
  existing knowledge (e.g., other energy models,
  and empirical literature on historical
  elasticities)
• While a wealth transfer (and not a social gain),
  the effect of RE on gas prices is significant a
  reduction in gas bills due to RE could largely
  offset any expected incremental cost of RE
• More thorough analysis is warranted effect
  should be better integrated into RE cost and
  benefits analysis

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The External Consumer Benefit of Renewable
Energy
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Conclusions

• Gas prices are high, volatile, unpredictable, and
  diversification with RE can help hedge these
  risks
• Directly hedge gas costs
• Reduce gas consumption and prices
• More sophisticated risk analysis tools have the
  possibility of expanding the use of renewable
  energy
• Recent IRPs Those IRPs that have evaluated
  natural gas and carbon risks are now regularly
  finding that wind power is a beneficial
  contributor to a low-cost/low-risk portfolio
• Secondary Gas Impacts Studies of the impact of
  renewable energy on gas prices show potentially
  sizable benefits that may tip the scales in favor
  of renewable energy

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What Is Needed?

• Apply more sophisticated risk analysis tools in
  assessments of the cost and benefits of renewable
  energy
• Utilize the techniques that are increasingly used
  in utility IRPs
• Develop better understanding of the range of
  plausible future gas prices
• Understand different hedging options and their
  limitations, and what risks renewable energy can
  and cannot hedge cost effectively
• Develop methods to quantify other risk benefits
  (and costs) of renewable energy, and popularize
  their use (e.g., risk of future environmental
  regulations)
• Develop tools to better address the tradeoff
  between the cost and risk of different resource
  portfolios
• Customer surveys of willingness to pay for price
  stability
• Develop more green power options that provide the
  benefit of price stability
• Generate a better understanding of the impact of
  RE on gas prices, focusing on the inverse price
  elasticity of gas supply

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Contact Information

• Ryan H. Wiser
• Lawrence Berkeley National Laboratory
• 1 Cyclotron Road, MS 90-4000
• Berkeley, California 94720
• RHWiser_at_lbl.gov
• 510-486-5474
• Reports available at
• http//eetd.lbl.gov/ea/ems