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Getting It Right: The Real Cost Impacts of a Renewables Portfolio Standard

Fortnightly Magazine - February 15 2000

and a riskless T-bill. We begin with Equation (2):

sp = SQRT { x12 s12 + x22 s22 + 2x1x2r1,2 s1s2 }

where the subscripts 1 and 2 now reflect, respectively, the risky security and the riskless asset. In the case of riskless asset s2 = 0.0, so that Equation (2) reduces to the linear relationship

sp = SQRT { x12 s12 } = x1 s1 (3)

Equations (1), (2) and (3) are used to create Figures 1-4 in this article. These equations rely on a set of assumption that may not always hold in the case of real (i.e., non-financial) assets such as a portfolio of generating resources. The standard assumptions require the existence of perfect markets for trading assets, which generally implies low transactions costs, perfect information about all assets[Fn.29] and prices that follow a random walk - a condition that in fact seems to be empirically supported by the evidence for fuel prices.[Fn.30]

The market for the generating assets may be less than perfect and unlike financial securities, which can be readily sold, generating assets are less liquid. In addition, financial securities are almost infinitely divisible so that a portfolio can contain between 0 percent and 100 percent of a given security.[Fn.31] Generating assets are quite lumpy by comparison, which may cause discontinuities. For example, the optimal portfolio for a region may include 1.5 units of a particular resource, although such concerns diminish in the case of national energy planning where the lumpiness of individual units of capacity additions becomes relatively insignificant. Given these caveats, it is also important to note that portfolio theory commonly is applied to the valuation of tangible, non-financial assets, in spite of these limitations.[Fn.32] - S.A.

1 For example, Bernow, Steve, Bill Dougherty and Max Duckworth, "Quantifying the Impacts of a National, Tradable Renewables Portfolio Standard," Electricity Journal, Volume 10, No. 4, May 1997, 42-52. The authors estimate the costs associated with the Minimum Renewables Generation Requirement in the Schaefer Bill (H.R. 3790, 104th Congress), which calls for a renewables component of 4 percent (excluding hydro) by the year 2010. See also Berry, David and Ray Williamson, "Solar Power and Retail Electric Competition in Arizona," Solar Today, Volume 11, No. 12 March/April 1997 34-37. The authors discuss the Arizona RPS (since withdrawn), which required that providers include between 1 percent and 2 percent renewables in the resource mix.

2 Bernow, et. al. [1997, at page 50] estimate a cost increase in the range of 0.1 percent to 1.6 percent by the year 2010 [ibid. at 47], or about 0.03 cents per kilowatt-hour [ibid. at page 50]. Berry and Williamson [1997, at p. 36] find that the Arizona RPS would have increased cost by 0.13 cents per kilowatt-hour - pretty much the same story.

3 For the moment, we can define risk as the year-to-year fluctuations in overall generating costs. Such fluctuations are primarily driven by the systematic changes in fossil fuel prices. They cannot be diversified simply by adding different types of fossil fuel, since fossil prices are highly correlated. Other risks, such as