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Getting It Right: The Real Cost Impacts of a Renewables Portfolio Standard
How to justify green power without apologizing for the price.
Policymakers have shown considerable interest in the concept of a renewable portfolio standard (RPS), and how it might affect the cost of energy.
The RPS would require electricity providers to include a small amount of renewables-based power - typically less than 3 percent or 4 percent - in their resource mix. Several recent analyses estimate the costs associated with RPS requirements[Fn.1] and draw similar conclusions: They find that any additional costs incurred in attaining the desired levels of renewable energy are "minimal"[Fn.2] as compared to an all-fossil portfolio. This finding is then used to justify portfolio standards as a reasonable means of accelerating the diffusion of renewables, which is seen as a socially desirable, national objective. The message reads like an apology. With "hat in hand," these advocates tell the policy-makers, in effect, "Promoting renewables is a good idea, which will not cost too much."
In reality, however, that message gets it wrong - it sells renewables short. The prediction that renewables will raise overall generating costs flies squarely in the face of portfolio theory, a well-established part of modern finance.
Indeed, the standard RPS cost analysis arrives at this result by focusing on the direct cost of investing in renewables while ignoring the other important aspect - the favorable effect on portfolio risk that results because the costs incurred for renewable generation are generally fixed over time. In effect, we can think of renewable energy as essentially riskless,[Fn.3] which allows us to consider more properly the RPS concept using a finance-oriented analysis that weighs fuel price risk as well as the overall weighted-average generating cost.
If renewables in fact do raise portfolio costs, as previous studies show, then it would make little sense to mandate portfolio strategies in the name of altruism and nationalism, even if the percentage cost increases were small. Given the magnitude of our national outlays for electricity, even small percentage increases have a way of translating into serious dollar amounts. When we examine the RPS idea using finance theory, however, it turns out that renewables have a very favorable impact. Indeed they serve to reduce overall generating cost at a given level of risk; or, in the alternative, they reduce overall risk at a given cost. It is this reduction in risk and/or cost, rather than altruism or vaguely derived "green targets," that should provide a sound basis for RPS in our national policy.
How can renewables accomplish the neat trick of reducing portfolio cost? Don't they cost more than fossil alternatives? The short answer is, yes, they do cost more on a stand-alone busbar basis. But renewable technologies such as photovoltaics (PV) or wind are different - they are "passive" in the sense that they have no state of "on" or "off."[Fn.4] When included in an all-fossil portfolio, such renewables will reduce electricity costs, or risk, or both. This counter-intuitive result, which makes it seem that the economist's proverbial "free lunch" actually may exist, stems from the unique characteristic of such passive technologies: They are