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Gas-fired Generation: Can Renewable Energy Reduce Fuel Risk?

Fortnightly Magazine - May 1 1997

through fixed-price contracts of varying duration.

Our findings suggest that there exists a substantial risk-reduction benefit of wind energy under a range of conditions. With traditional regulation, the benefit for ratepayers is around $3.40 per megawatt-hour to $7.80/MWh. Company shareholders get no benefit because most risks under this system of regulation are passed on to the customers. In the unregulated scenarios, risks are divided differently between shareholders and consumers so the benefits of the wind investment are divided differently as well. In a power pool setting, we found that utility shareholders would receive the equivalent of an extra return on equity (ROE) of 1 to 1.5 percentage points, but consumers would end up worse off. Fixed-price contracts of a one- to five-year duration appear to share risks more evenly between customers and shareholders, giving both groups a modest incentive to choose wind.

Whether risk considerations tip the balance in favor of wind and other renewable resources must be considered case by case. Electricity from new gas plants is undoubtedly inexpensive, and substantial greenhouse gas restrictions or taxes may arise some

distance down the road. Moreover, other risk-management options, such as long-term fuel contracts, may be available. Nevertheless, our TU study showed that risk considerations could transform the wind plant from a clear loser into nearly a break-even proposition for that utility.

Regulatory Scenarios:

Effects on Risk

First, we review the base (fossil) and alternate (wind) plans under expected conditions, that is, allowing no deviations in fuel prices, load growth, environmental costs or plant availability (see Table 1). The cost streams are discounted at two different discount rates, the utility's weighted average cost of capital (WACC), 9.64 percent, and the presumed risk-free discount rate, 7.5 percent. In either case, the forced addition of the wind plant in 2003 increases revenues and net income and decreases costs. (Note that net income equals revenue minus cost.) The higher net income is necessary to compensate company shareholders for their larger investment in the wind plant, as is evident from the fact that the return on equity (ROE) in both cases is the same.

If risks and environmental externalities were ignored, the gas-fired, combined-cycle unit would be the preferred choice, since it is approximately $300 million less expensive for ratepayers. Taking risk factors into account can change this picture, however, depending on how the market allocates risk between customers and shareholders.

Traditional Regulation. In this scenario, electricity prices are not market-determined but set by the regulatory system to achieve a target rate of return on equity for TU Electric's stockholders. Changes in fuel prices and environmental costs are passed on to customers through a fuel-cost adjustment

to the base electricity rate.

Consequently, it can be expected that shareholders will have the least to gain from investing in wind as a risk-management strategy, whereas ratepayers will have the most to gain.

This result can be illustrated in a table that shows the expected present value and standard deviation of revenues, costs, net income and average return on equity for both the gas and wind cases and the differences