A defense of the total return to shareholders (TRS). Our authors use TRS as the bottom-line performance indicator, and come up with a number of performance insights.
Green Options On the Future
Call options can be used as a financing tool for fixed-cost renewable energy technologies.
In the 3.5 percent case, the price never exceeds 8 cents/kWh, so the call premium is all profit. If wholesale price inflation is 7 percent a year, the call seller ends up with less total revenue, but still may prefer selling calls, since it shifts revenue forward in time.
The revenues above do not capture the benefit of reduced debt finance costs for the call-option seller. The cost of financing the initial project represents a large fraction of the wind operator’s annual cost (60 percent in the wind-farm example). Clearly, selling call options can reduce this cost significantly. Forgoing potentially higher future electricity prices is a risk. Nevertheless, it may be viewed as a desirable tradeoff considering the more certain benefit of recovering one-fourth of capital costs immediately.
If the wind farm would produce energy beyond 20 years, say for 30 or 40 years, and one could find willing call-option buyers for the later years, it would be possible to underwrite an even greater portion of the plant capital costs. Since the value of call options increases with more time or more volatility, one can imagine a situation where proceeds from call options are sufficient to pay the entire capital cost. At that point, all the actual electricity sold would be pure profit, whether it was sold at the price cap agreed to under the call-option contract or at prevailing market rates. Perhaps more realistic (given initial liquidity and default/security concerns) would be a situation where a wind farm recovers 5 percent to 10 percent of its investment from selling calls upon project completion, and recovers most of its O&M costs each year from selling a new option 25 or 30 years out.
If renewable-energy producers were to exploit (or at least effectively communicate) the value of predictable operating costs over the long term, they would change perceptions about the cost of renewable energy. Future electricity prices are uncertain because of many factors, but a significant one is the volatility of fossil-fuel prices. Examples illustrated both the costs and benefits available to long-term call option buyers and sellers. Renewable energy sources can and should capture the value that they inherently provide: stable energy prices.
Considerable time and effort has been spent lobbying legislatures for production tax credits and renewable portfolio standards as well as for creating “artificial” markets for green tags, renewable energy credits, and voluntary (in the United States) trading of carbon emissions. It is surprising that an inherently market-oriented solution such as selling call options based on predictable long-term operating costs of fixed-cost renewable electricity has not yet been exploited properly.
In the examples presented above, the call-option buyer paid a current electricity price of 10 cents/kWh and the call option seller received a price of 4 cents/kWh. In part, these different prices reflect the real cost of delivering energy (distribution) from producer to user as well as different pricing in retail versus wholesale markets. There is an opportunity to narrow that gap in the United States electricity market, and to do so profitably. One way would be for electric