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Getting It Right: The Real Cost Impacts of a Renewables Portfolio Standard
their preferences by adding riskless assets in Portfolio M or by using leverage. That means that all investors, independent of their risk preferences, will hold Portfolio M. This result has significant implications for national energy planning since it clearly implies that in the presence of riskless renewable resources, there exists a unique optimal mix of risky (fossil-based) alternatives that is independent of individual preferences and risk aversions.
The Riskless Alternative
The financial risks associated with PV, wind and other passive, capital-intensive renewables are very similar to those of "riskless" U.S. Treasuries. Such technologies are essentially riskless in the sense that their year-to-year costs are virtually unchanged. To be sure, they can never eliminate all uncertainty. For example, the value of renewable-based generating assets may rise and fall with the market price of electricity just as the value of U.S. Treasuries changes with inflation. But year-to-year market valuations are not relevant since PV installations presumably are intended to be a "going concern" for the life of the modules. That makes their risk entirely analogous to U.S. Treasuries, which are "riskless" on a nominal basis only if held to maturity.
There are other risks: Some arrays may fail prematurely. But even if not covered by manufacturer's warranties, the risks of failure are random and unsystematic (i.e., uncorrelated to overall economic cycles or to fossil fuel prices) and hence easily diversifiable. For example, in any large installation it might be reasonable to expect a certain number of modules to fail each year. These costs can be planned for - like the furniture reserve in a hotel - and hence are not "risky." The important point is that these failures are random and therefore uncorrelated with the systematic movement of fossil prices over time.[Fn.13] Random costs always are diversifiable and thus not relevant to portfolio analysis.
In short, PV and wind come about as close as real assets can to mimicking the zero-beta properties of T-bills. PV-based generation has an essentially fixed or "zero-beta" cost, which - like the nominal T-bill interest payment - is virtually certain and hence "riskless" for all practical purposes.[Fn.14]
Evaluating Generating Portfolios:
This section uses historic data to develop cost-risk results for a fossil portfolio consisting of gas and coal, then shows the effects of including riskless renewables, such as PV or wind.[Fn.15] The analysis is offered as illustrative only - not so much to form firm policy recommendations as to call attention to the value of portfolio theory in attacking the problem. It shows that resource alternatives should not be evaluated solely on the basis of their stand-alone costs, but on the basis of their contribution to the overall cost and risk of the portfolio of generating alternatives.
The analysis is based on annual coal and gas fuel price data for the period 1975 to 1999,[Fn.16] and on the following levelized generating costs: coal - $0.08 per kilowatt-hour, gas - $0.05 per kilowatt-hour, PV/wind - $0.12 per kilowatt-hour. These are not current costs, but represent the levelized total cost, going forward, over the life of the assets.