Editor’s note: This executive summary, from the paper Revisiting the long term hedge value of wind power in an era of low natural gas prices, is authored by Mark Bolinger at the Lawrence Berkeley National Laboratory. Download the full copy here: http://emp.lbl.gov/sites/all/files/lbnl-6103e.pdf
Expanding production of the United States’ vast shale gas reserves in recent years has put the country on a path towards greater energy independence, enhanced economic prosperity, and (potentially) reduced emissions of greenhouse gases and other pollutants. The corresponding expansion of gas-fired generation in the power sector – driven primarily by lower natural gas prices – has also made it easier and cheaper to integrate large amounts of variable renewable generation, such as wind power, into the grid. At the same time, however, low natural gas prices have suppressed wholesale power prices across the nation, making it harder for wind and other renewable power technologies to compete on cost alone – even despite their recent cost and performance improvements. A near-term softening in policy-driven demand from state-level renewable energy mandates, coupled with a possible phase-out of a key federal tax incentive over time, may exacerbate wind’s challenge in the coming years. As wind power finds it more difficult to compete with gas-fired generation on the basis of near-term cost, it will increasingly need to rely on other attributes, such as its “portfolio” or “hedge” value, as justification for inclusion in the power mix.
This article investigates the degree to which wind power can still serve as a cost-effective hedge against rising natural gas prices, given the significant reduction in gas prices in recent years, coupled with expectations that prices will remain low for many years to come. It does so by drawing upon a rich sample of long-term power purchase agreements (“PPAs”) between existing wind generators and electric utilities in the U.S., and comparing the contracted prices at which utilities will be buying wind power from these existing projects for decades to come to a variety of long-term projections of the fuel costs of gas-fired generation modeled by the Energy Information Administration (“EIA”). The wind PPA sample – consisting of 287 contracts totaling more than 23.5 GW of operating wind capacity in the U.S. – exhibits a high degree of long-term price stability.
On average and in real dollar terms, buyers of the wind energy in the PPA sample will pay no more per MWh twenty years from now as they do today. In contrast, natural gas prices are difficult to lock in for any significant duration, making it hard to capitalize on today’s low prices. Although short-term gas price risk can be effectively hedged using conventional hedging instruments (such as futures, options, and bilateral physical supply contracts), these instruments come up short when one tries to lock in prices over longer terms – e.g., greater than five or ten years. It is over these longer durations where inherently stable-priced generation sources like wind power hold a rather unique competitive advantage.
Comparing the wind PPA sample to the range of long-term gas price projections reveals that even in today’s low-gas price environment, and with the promise of shale gas having driven down future gas price expectations, wind power can still provide long-term protections against many of the higher-priced natural gas scenarios contemplated by the EIA. This is particularly true among the most recent wind PPAs in the sample, which likely better represent current wind pricing, at least on a national average basis. These newer wind contracts not only provide ample long-term hedge value, but on average are also directly competitive with gas-fired generation in the near term.
Lawrence Berkeley National Laboratory
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