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Economy of Scale: Doing Better Than "Bigger" in Renewable Energy

Renewable energy is experiencing a scale-up of unprecedented proportions. In the past five years, U.S. wind and biofuel production has nearly tripled; numerous states have enacted renewable energy standards to guarantee further increases; and, as production capacity has increased, costs have dropped. But bigger isn't always better.

What are the diseconomies of large-scale renewable energy? How will massive wind farms and ethanol plants change the rural landscape? How can farmers and rural residents become owners in the renewable energy revolution rather than observers?

For the renewable energy enthusiast, there's a tendency to focus on the size of the industry rather than its nature. This tunnel vision on "more" overlooks the substantial benefits of local ownership. Ten, 33 million gallon ethanol plants produce as much as three, 100 million gallon plants. But while the latter may foster a modest and short-term improvement in the local economy (and largely benefit the absentee owners), the former may have thousands of local owners and represent an enduring economic foundation.

Locally-owned ethanol plants—representing one-third of U.S. capacity—pump 5-30% more economic impact into the local economy than equivalent absentee-owned plants. Much of this impact comes from the $.30-$.40 cents per bushel dividend payment farmer-owners receive annually. If 300 million gallons of ethanol was produced via ten locally-owned plants instead of three, large absentee-owned ones, the host communities would see nearly $40 million in dividends.

Wind energy can also be developed locally, with substantial local economic benefit. The local and regional economic impact of a locally owned wind farm is 25-300% greater than an absentee-owned turbine. The local farmer may get $100,000 in lease payments over the 20-year turbine life, but as an owner, she could earn easily over $1 million. The difference between ten locally-owned 20 MW wind farms and one absentee-owned 200 MW wind farm is almost $90 million in revenue to local owners.

Local ownership weds energy policy and rural development policy. When farmers can own renewable energy production, they can escape the chains of volatile commodity prices. When rural communities become owners, they can be more self-reliant. The federal government already supports renewable energy with production incentives and rural communities with development programs, in separate accounts. The combination of energy development with rural local ownership creates an economy of scale—every dollar of federal money spent on locally-owned renewable energy pays back into the community.

Local ownership doesn't happen by default. When activists and policy makers focus on gallons and megawatts it becomes a policy preference for massive ethanol plants and large wind farms. Conventional wisdom suggests that this size preference minimizes unit costs. However, a new report from the Institute for Local Self-Reliance shows that the size of cost savings is modest, perhaps undetectable in the retail price. Meanwhile, the benefits of local ownership are lost, since farmers can't afford to finance the largest facilities.

The average ethanol plant in 2002 produced 40 million gallons a year. Half were farmer owned. Today, proposed ethanol plants will typically produce 100 million gallons annually and less than 20% of new capacity—mostly expansions of existing plants—will have farmer owners. The larger plants will produce and sell ethanol for perhaps 2 cents per gallon less than smaller plants, shaving less than 1% off the wholesale price of ethanol.

Wind is also scaling up. The average wind farm under construction is 80 MW, three times bigger than the largest locally-owned project. Over a dozen proposed projects exceed 200 MW. A large, 200 MW wind farm can produce electricity for 25% less than an otherwise equivalent local 10 MW wind farm, but large wind farms often need new transmission lines to send their power long distances. If a 200 MW project sends its power 500 miles, transmission costs and losses largely offset its economic advantage.

On the other hand, twenty 10 MW projects injecting their electricity into the existing transmission system could produce the same power at close to the same cost while also providing substantial local economic benefits.

Scaling up individual facilities along with overall renewable energy production promises one economy of scale at the expense of another. Larger wind farms and ethanol plants modestly lower the cost of electricity and fuel, but price out local owners. Instead, there are opportunities to continue the rapid expansion of renewable energy with a policy economy of scale: combining energy and rural development.

In the next five years, both wind and ethanol production could double again. If the additional 13,000 MW of wind was locally-owned it could add $300 million to rural economies. If the additional 5 billion gallons of ethanol production were owned locally, it could add another $650 million in farmer dividends. That's $1 billion of rural development in concert with doubling renewable energy production.

One state has already used policy to prioritize this economy of scale. Minnesota's Community-Based Energy Development statute offers a favorable tariff for locally owned renewable energy projects, requires 51% ownership by Minnesota residents, and designates 51% of financial benefits to local owners. Since 2005, it has ushered in over 150 MW of community-owned wind and made hundreds of rural residents into energy producers. Minnesota leads the nation in locally-owned wind with close to 400 MW built or contracted and the state's 4th-ranking 967 MW of wind capacity shows that community-based policy is compatible with large-scale renewable energy production.

There's also an opportunity to support local ownership nationally. The federal production tax credit (PTC) is the most substantial incentive given to renewable energy producers, but it can only be applied to passive income (e.g. rental income), which few citizens have. Two Minnesota Representatives, Walz and Peterson, have introduced a bill (HR 2691)—currently before the House Ways and Means Committee—to allow the PTC to be taken against ordinary income. This amendment would allow many more Americans to access the tax credit, and become investors in renewable energy.

Rapid growth of the renewable energy industry requires economies of scale. The status quo rewards ever-larger production facilities for rather modest reductions in costs and indirectly reduces local ownership. A policy of locally-owned renewable energy production, however, could pour nearly $1 billion into rural economies via thousands of rural owners. That's an economy of scale.

John Farrell is a research associate at the Institute for Local Self-Reliance, where he examines the benefits of local ownership in renewable energy. His latest paper, Wind and Ethanol: Economies and Diseconomies of Scale, uncovers why bigger isn't necessarily better. He's a graduate of the University of Minnesota's Humphrey Institute of Public Affairs and currently resides in Minneapolis, Minnesota.

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