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

Fortnightly Magazine - May 1 1997

decision analysts generally assume it is approximately equal to the reciprocal of one to two times expected income. In this study, we assume, from the perspective of ratepayers, the risk aversion coefficient equals the reciprocal of 1.25 times revenues, whereas from the perspective of shareholders, it equals the reciprocal of 1.25 times expected return on equity. %n1%n

When the equation is applied to the annual means and standard deviations calculated by the model, and the wind and gas cases are compared, the result is an estimate of the total risk-reduction benefit of wind energy. (See Table 3. Note: The figures in this table have been divided by the amount of energy displaced in the substitution of the wind plant for the gas plant.) The total benefit is made up of two components, a change in mean revenues (due in our study entirely to environmental regulatory risks), and a change in the risk premium. Together, they show the consequences of allowing for risks in the comparison of the two resource options.

In the regulated market scenario, the benefit to the utility customer is equivalent in real levelized terms to $3.4/MWh to $7.8/MWh. The benefit is slightly smaller in the fixed-price contract scenario and actually negative in the power pool scenario. This means the customer is slightly worse off with wind in the power pool mix. The explanation for this last effect is unclear, but is likely connected to the way wind energy affects the dispatch of high-cost fossil-fuel plants operating at the margin.

The risk benefits from the shareholder's perspective are the

mirror image of those from the customer's perspective. In the power pool scenario, shareholders receive a major risk benefit from the wind plant that is equivalent to an extra return on equity of 1.2 to 1.5 percentage points. In the contract scenario, the benefit to shareholders appears smaller but still substantial (em 0.2 to 0.5 percentage points. As already noted, there is little or no risk benefit for shareholders in the regulated market scenario.

Market Implications

For the most part, accounting for risk points to benefits in adding wind energy to the fuel mix. The greater uncertainty in the annual average availability of wind plants compared with conventional plants does not offset the benefits of reduced exposure to fuel-price and environmental regulatory risks. This finding does not mean wind plants should always be selected, of course. In today's market, natural gas is so inexpensive that even considering risk factors it is still often the cheapest investment. However, risk could become a decisive factor when the cost differential between resources falls below $5/MWh.

Risks are distributed much differently in a regulated market than in an unregulated market, however, a fact that also affects the decision reached. In a regulated market, utility company shareholders see few of the risks of fossil fuels and so have little incentive to invest in risk-mitigation options such as wind power. This difference may help explain why many utilities have not eagerly embraced wind and other renewable resources in the past. An unregulated market may provide greater incentive