Here’s Something You Need to Know About the Growth of Renewable Energy

This year’s Climate and Society class is out in the field (or lab or office) completing a summer internship or thesis. They’ll be documenting their experiences one blog post at a time. Read on to see what they’re up to.

Thomas Greer, C+S ’16

Source: iea.org

Renewable energy in the U.S. has been growing rapidly as a source of electricity, but, nonetheless, the U.S. still has a long way to go before it catches up with other developed nations.

There are also two common misconceptions about renewable energy, and they are very closely related. First, most people assume that the only potential buyers of wholesale electricity traditional utilities that procure or produce power to provide to retail customers. The second misconception is that we are decades away from having to integrate large amounts of renewables to the electricity grid.

The main explanation for why those assumptions are no longer accurate is due to a single phenomenon — the rise of what are known as corporate PPAs.

The energy industry is notorious for jargon and acronyms, so I’ll try to keep it to a minimum, but this isn’t one that I could avoid. A PPA is a power purchase agreement, and it is the most commonly used structure for long-term electricity purchase by wholesale customers. In this context, the word “corporate” refers to companies that are not traditional utilities or typically affiliated with the electricity industry. In other words, any non-utility company on, say, the Fortune 500 list would be considered a corporate buyer.

The corporate PPA is a relatively new concept. Several years ago, it was an extremely rare occurrence. But by 2015, corporate PPAs accounted for more than half of the construction of new wind and solar facilities in the U.S. That is a pretty staggering number.

There are several reasons why a corporation may choose to procure renewable power at the wholesale level. One of these is internal sustainability goals. A number of corporations set them, and there’s even a growing subset committing to use 100 percent renewable power. Another reason is that renewable energy purchases provide a hedge against future electricity price volatility.

Electricity rates change fairly frequently. This is due to the fact that the price of the underlying fuel that is used to create electricity can be quite volatile (point in case: natural gas).

While it’s true that renewable energy has no fuel cost, renewable energy almost never sets the wholesale market price for electricity. It can affect the market price, but it has not become a large enough component of the energy mix to regularly set it. (A discussion of energy system supply and demand is beyond our discussion here). Point being, a corporate entity can enter into a long term contract with a renewable energy power producer whereby it pays a fixed rate for 10-20 years. In exchange, the floating wholesale market price gets passed to the corporate purchaser.

The math works like this: let’s say a wind energy developer needs $20/MWh over the life of a project to justify the financing and construction of a facility. Let’s also say that the average wholesale market price at the location of the wind farm over that same duration is $45/MWh. A corporate entity would, on average, pay $20 and receive $45 in return for each MWh of energy. So, not only would the corporate customer be achieving its sustainability goals, it would be making money in doing so! This, of course, begs the question as to why the renewable energy developer doesn’t just build the facility and take the $45/MWh for itself. The reason is that the $45 is uncertain, and that potential volatility makes financing very difficult.

The corporate customer does run the risk that the $45 instead becomes, say, $15. This would mean they lose money on the transaction. However, there are two key things to keep in mind. First, capital costs for renewables continue to decrease and the efficiency of renewables continues to increase—this makes it likely that the price that a developer needs to build a project will continue to be fairly low. Also, natural gas prices are very low right now, and the difference between $15 and $45 will largely be due to natural gas price evolution. Given inflation and other macroeconomic factors, all signs point to these prices, at the very least, remaining steady if not significantly appreciating over the next decade.

Nevertheless, the main takeaway is that the retail rate a customer pays is going to be directly influenced by the wholesale power price. If their retail rate shoots up, they will also be making money on the corporate renewable PPA that will offset the increase. If they are losing money on the corporate PPA, they are also paying less than expected for retail power. That’s why a PPA like this can serve as a hedge.

So, now we can (finally) move the the second misconception about the growth of renewable renewable energy. The integration of renewables is a key issue moving into the coming decades. When people talk about “integration,” they are talking about the ability to increase the amount of intermittent generation on the grid while maintaining reliability. (My research project this summer is actually looking at how climate information may — or may not — be able to help with the integration of renewable energy.) Over the years, the estimates of renewables growth have been driven by potential or existing public policies whether it’s a carbon tax or a renewable portfolio standard. Most current estimates are linked to the Clean Power Plan, the fate of which (not to mention the details) is highly uncertain. This means that most scenarios that include the integration of significant renewable generation take place at least 15-20 years away.

Now, to bring it all together — a key component of most corporate PPAs is that they are “virtual,” or purely financial. Whereas a utility usually enters into a PPA to purchase physical electrons and move those electrons to their customers, a virtual PPA means that only money changes hands. The actual electricity simply flows on to the grid to be used elsewhere. This structure results from the fact that most corporate customers don’t have regulatory authority to purchase wholesale power.

Essentially, due to the recent ubiquity of corporate PPAs, there is a large amount of renewable power being put on the grid that greatly exceeds previous estimates. Plus, there doesn’t seem to be any dissipation in their popularity in the near future. To the contrary, more and more corporates are indicating interest in this type of transaction and are setting goals that will require them. The end result will be more renewable energy flowing to the grid that must be managed, especially because there isn’t a traditional purchaser who can transmit and utilize the power.

It’s not who you think it is driving the growth of renewables. And the potential challenges with renewable energy integration need to start getting addressed now. If we wait on the Clean Power Plan or the Paris Agreement, we’ll be too late.