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Getting It Right: The Real Cost Impacts of a Renewables Portfolio Standard
devoid of systematic (as opposed to random) risk. To be precise, they have the attributes of a zero-beta technology.
For our purposes, we can think of the term "riskless" as implying that year-to-year generating costs are largely fixed and that any fluctuations are not correlated to movements in fossil fuel prices. It is not necessary that renewables be entirely free of risk, just that their risk properties be reasonably close to those of "riskless" Treasury obligations, which also are not really risk-free as discussed in subsequent sections. Renewable technologies may exhibit random risks - a component may fail or the wind may not blow on any particular day - but these random risks are diversifiable and do not affect portfolio analysis. Thus, in the overall sense, these riskless renewables are entirely analogous to the key role played by U.S. Treasury bills in a diversified financial investment portfolio. It is well known that when added to a diversified portfolio of risky stocks, Treasuries improve efficiency. They raise expected returns at any given level of risk, even though their own expected return is lower.
The important point is that (systematically) riskless renewables affect the resource mix along two axes - cost and risk. When added to the fossil mix, renewables might raise cost, but they will also lower risk. That means that we cannot make a meaningful evaluation by examining only cost (while ignoring risk) as previous studies have done. Any RPS "cost" assessment must be based on underlying theory, which shows how to estimate expected portfolio costs at various levels of risk. Indeed meaningful, apples-to-apples comparisons of portfolio costs "before" and "after" renewables can be made only by holding the risk constant. Portfolio theory tells us that when properly constructed, such a comparison will show that the addition of riskless renewables serves to lower overall generating costs.[Fn.5]
Of course, renewable energy is not entirely free of risk, and neither are U.S. Treasury obligations. Nevertheless, the arguments for including Treasury bills in a financial portfolio, and the implications they hold for renewables in the generating resource mix, are compelling:
* T-Bills Are Expensive. U.S. Treasury obligations are the most expensive investment generally available. Consider a hypothetical T-bill yielding 5 percent and a risky stock with an expected yield of 20 percent. To generate an expected income stream of $100 per year requires an investment of $500 in the stock, but a much larger investment of $2,000 in T-bills. The T-bills are "more costly" and yield less. This feature, plus their "riskless" character, makes renewables and T-bills virtually identical in the financial sense.
* Yet T-Bills Boost Performance. Textbook portfolio theory tells us that every optimal portfolio must contain riskless T-bills. Why? Because even though their yield is lower, their inclusion serves to increase the expected portfolio return at virtually any given level of risk.[Fn.6]
* Renewables Can Do the Same. Wind, PV and similar passive renewable resources can improve the performance of the generating portfolio in the same manner T-bills enhance financial portfolios. Photovoltaics and other passive renewables are systematically riskless, for all practical