An ever better bet: US utilities see less risk and more profit in renewable energy

Merchant companies have built most of the renewable power in the US. But as renewables become a more sure-fire bet, utilities are taking an increasing ownership share in projects. Elisa Wood looks at this new market evolution.

When the US liberalized its power markets, regulators in many states defined clear roles for utilities versus merchant companies. Private developers would take the gamble associated with building and owning power plants; risk-adverse utilities would deliver the power over the wires to customers at a guaranteed profit.

New Hampshire, however, took a slightly different path. Despite the state’s Libertarian reputation (as evidenced by its slogan: Live Free or Die), it did not fully deregulate. Instead, state lawmakers allowed Public Service of New Hampshire (PSNH) to retain about 1100 MW of mostly coal-fired generation. The subsidiary of Northeast Utilities would buy its remaining supply through competitive contracts.

Some of the 3 MW wind turbines at SMUD”s Solano County wind farm, California SMUD

Thus was born what the utility now calls the ‘hybrid’ competitive market, a utility portfolio that mixes the old-world, rate-based utility generation with a new world of market-priced competitive sources. The utility claims the approach has worked well, allowing it to hedge the market and keep rates relatively low when competitive power costs skyrocketed in the north east.

Now the utility wants state lawmakers to let it expand its hybrid structure, but with a new twist. It is not just any kind of power plants that PSNH wants to build. It’s renewables.

PSNH’s pursuit of renewable power plants is in keeping with a growing trend across the United States. Even in many areas that did not liberalize markets, merchant developers – the risk takers – were the first out of the gate to build and own green energy in significant numbers. Utilities were content to take the safer road and contract with private developers for clean power.

For example, in the wind energy market, out of the total 11,575 MW of capacity installed in the US by the end of 2006, merchant owners (also known as independent power producers or non-utility generators) owned 85%, or 9817 MW, according to the Annual Report on U.S. Wind Power Installation, Cost, and Performance Trends: 2006 by Ryan Wiser and Mark Bolinger of the Lawrence Berkeley National Laboratory.

Utilities owned only 13% of wind capacity, with 190 MW held by investor-owned utilities and 309 MW by publicly owned utilities. (The remaining 2%, or 258 MW, was owned by community wind entities.)

TABLE 1. Major owners of wind power facilities in the United States

But now that wind has proven its worth, an increasing number of cautious utilities are venturing into the ownership waters, according to the Wiser/Bolinger report. In fact, utilities accounted for 25% of total wind additions in 2006.

Not surprisingly, renewable energy topped a list of new investment opportunities described by PG&E Corp in a recent investor presentation made at the Sanford Bernstein CO2 conference in New York. California-based PG&E, which owns one of the nation’s largest investor-owned utilities, rounded out its investment wish list with several close cousins of renewable energy: distributed generation and energy storage, smart energy technologies and infrastructure for plug-in hybrids and alternative fuel vehicles.

The growing interest among utilities in renewable investment also became apparent during this year’s American Wind Energy Association conference in Los Angeles. More than 200 people who attended the conference in June were from utilities, a record number, according to the organization.

Follow the money

Utilities cite many reasons to pursue renewable plant ownership: Lowering customer rates, providing environmental stewardship, meeting expected greenhouse gas restrictions and spurring local job growth.

Ultimately, though, it may be simply that they see a strong revenue source in green energy: ‘My underlying suspicion is that it’s quite profitable for them or it wouldn’t be something they are looking to do,’ said Patricia Stanton, Vice-President and Director of the Clean Energy Markets Division at Conservation Services Group, a national, non-profit energy services firm that provides a range of renewable services.

One of the most eye-catching moves of the last year came from Xcel Energy. Already the country’s largest utility contractor of green energy, Xcel announced it now wants to own wind farms. The Minnesota-based utility, which has $9 billion in annual revenue and operates in eight states, is a significant US player in the wind market. By year-end, it had 1323 MW of wind capacity installed on its system, most of it obtained through contracts with merchant owners. The utility plans to more than double its wind capacity to 2800 MW by the end of 2007. Its long range plan is to have 6000 MW of wind on its system by 2020.

‘We would like the opportunity to grow financially with the industry,’ explained Paul Bonavia, President of Xcel Energy, speaking at the AWEA conference.

In late June, Xcel Energy asked Minnesota regulators for permission to build and own the Grand Meadow Wind Farm, a 100 MW project near Austin, Minnesota. The company plans to contract with enXco Development Corp, an EDF-EN company, to do the actual construction, which it expects to complete by the end of 2008.

Figure 1. Generation by fuel in 2030 (billion kWh)

Dave Sparby, acting president and CEO of Northern States Power Co-Minnesota, an Xcel Energy company, said that wind farm ownership makes sense at this time: ‘Not only does it diversify the company-owned generation portfolio, it will produce energy that is emissions-free and it reduces the price risk that can occur with dependence on more volatile fossil fuels.’

In Minnesota, the utility estimates that it will need to add between 3000 MW and 3400 MW of new wind generation to its system by 2020 to meet the renewable energy standard the state approved earlier this year.

Xcel Energy also recently unveiled plans to build or purchase 200 MW of wind power resources by 2011 in North Dakota, considered one of the nation’s best states for wind energy potential. The utility does already own one small project in the state, a 12 MW wind farm near Velva.

While North Dakota does not have an RPS, it has set an ‘objective’ to acquire 10% of its power from renewables. The state also offers tax incentives related to wind energy. ‘These factors, along with our plans for increased investments in electricity transmission facilities, make this an ideal time to expand our wind energy portfolio in North Dakota,’ said Xcel’s Bonavia.

Too many chasing too few RECS?

With consumer demand growing for green pricing programmes and more states adding renewable portfolio standards, utilities are worried about getting caught short in what could become a tight market for renewable energy certificates (RECs).

‘We need to have renewable energy as a permanent feature in our resource portfolio,’ said Jan Schori, general manager of the Sacramento Municipal Utility District (SMUD), which is the sixth largest publicly owned utility in the US and has one of the largest green power pricing programmes in the country.

Schori, who discussed the topic at AWEA’s wind conference, added: ‘We are looking for long-term solutions to meet the need; otherwise I am constantly out looking for new resources, and I’m up against every other load-seeking entity.’

The 735 MW Horse Hollow Wind Energy Center, Texas, is the largest operating wind farm in the United States and the world, according to FPL Energy FPL ENERGY

SMUD has set an internal target to supply 23% of its retail electricity sales with renewables by 2011. The utility owns a 39 MW wind farm in Solano County, California, and plans to expand its holding to 200 MW on the 6345 acre site. The utility also is considering possible development in Oregon, with an eye toward creating geographic portfolio diversity.

In New Hampshire, the state’s new RPS is one of the reasons that PSNH wants to build renewable energy. Approved in April, the standard requires that 25% of power sold to customers come from renewables by 2025.

The utility wants to develop biomass projects that use wood chips produced by local loggers. PSNH already owns the 50 MW Northern Wood Power Project, which it says is the largest coal-to-wood repowering conversion in the US. The project sells RECs into nearby states to offset its capital costs.

Lawmakers, however, nixed a measure this spring that would have allowed PSNH to build similar wood-chip projects. The legislation failed under strong lobbying by merchant companies. The utility says it expects to try to win approval again during next year’s legislative session.

Figure 2. Utility interest in wind asset ownership strengthens, community wind grows … but independent power producers continue to dominate ownership. Source: ‘Annual Report on U.S. Wind Power Installation, Cost, and Performance Trends: 2006’, Ryan Wiser and Mark Bolinger, Lawrence Berkeley National Laboratory, May, 2007

PSNH worries because RECs trade as high as $54/MWh in nearby Massachusetts, and utilities are sometimes forced to make penalty payments to the state because they cannot find enough of the certificates. With little renewable energy built in the region, PSNH fears that New Hampshire will face the same pressure.

But Constellation NewEnergy and other merchant suppliers argue that market entry by regulated utilities is unneeded. The market has turned, they say, and private developers are increasingly willing to brave New England’s difficult siting laws and not-in-my-backyard opposition. Moreover, large players with deep pockets, who can withstand prolonged battle, are moving into the region. For example, Spanish-utility Iberdrola now owns the company developing the 24 MW Lempster Wind project in New Hampshire.

The New England Power Generators Association also challenges whether New Hampshire’s hybrid market has truly been a success story. Rates have increased on average 8% in the state since 1998, says the advocacy organization.

Most of all, merchant generators say allowing utilities to build in competitive markets places too much risk on the captive ratepayer. If the wind farm fails, utilities typically recover losses in their rates. That is, the ratepayer covers the cost of the failure. On the other hand, if a merchant-built plant fails, private investors pay. Such guaranteed cost recovery gives utilities an unfair market advantage, say merchant developers.

Wind risks increasingly acceptable

In addition to owning more wind facilities, utilities continue to be the largest buyers of wind supply from other sources. Investor-owned utilities purchased 58% of cumulative wind capacity last year, and public utilities 14%, according to the Wiser-Bolinger report.

However, power marketers, or so-called merchant re-sellers, have dramatically increased their activity in the market. As of the end of 2006, power marketers were purchasing power from 16% of the installed wind power capacity in the US, according to the report.

The Wiser-Bolinger study also found that wind project owners are starting to take on some merchant risk. In other words, at least some portion of their electricity sales revenue is tied to short-term or spot market sales. The owners of 32% of the wind power capacity added in 2006 accepted some merchant risk, with most of the activity in Texas and New York. Both states are fertile ground for such activity because they have wholesale spot markets that wind power can compete in, and offer additional revenue from the sale of RPS-driven RECs.

Indeed, the RPS continues to be a major driver for wind development, according to the Berkeley Lab, which estimates that about 60% of wind development was motivated, to some extent at least, by state RPS requirements.

Typically under RPS rules, utilities and competitive retail suppliers are the entities held accountable for meeting the standard. That is, a percentage of the power they sell to retail customers must come from renewables. Given that utilities still serve far more customers in the US than retail suppliers, utilities shoulder the greatest burden to meet the standard.

So if a national RPS is enacted, the pressure is likely to increase for utilities to build and own wind power and other renewables. Such a standard was under debate in Congress at press time for this article.

The US Energy Information Administration conducted an analysis in June 2007 of the impact of a 15% national RPS by 2030. It found the renewables development was likely to ramp up significantly. To meet the RPS, the US would need to increase wind production by about 50%, from 52 billion kWh to 76 billion kWh; triple biomass generation, from 102 billion kWh to 318 billion kWh; and increase solar five-fold from 7 billion kWh to almost 38 billion kWh.

Impact of 15% RPS by 2030

Meeting growth targets for green energy will require an enormous national effort, given not only increasing RPS standards but also likely carbon emissions limits. Moreover, US demand for all power is simply growing, more rapidly in some areas of the country than analysts had expected, due to a increased use of air conditioning and electronic gadgets, coupled with an expanding economy. As a result, federal studies forecast a 40% increase in demand by 2030.

‘Allowing us to build a little bit of renewable energy is not threatening to the competitive marketplace. There is plenty of need out there for new renewable energy,’ said Martin Murray, PSNH spokesman.

The GF Energy 2007 Electricity Outlook, an annual survey of senior executives in the US and Canada, found growing concern that the industry will not be able to meet surging demand. Only 53% of respondents were confident that their company will be able to provide needed supply over the next five years, according to the survey sponsored by the American Public Power Association, Canadian Electricity Association, Edison Electric Institute, Electric Power Research Institute and the National Rural Electric Cooperative Association. Meanwhile, other survey results showed that companies are deferring making generation commitments.

‘There is a tremendous amount of load growth happening; it is surprising most of us. It is causing us concern about how we will keep up with it. The consequence is that there is going to be fierce competition for resources,’ said Stephen Wright, administrator for the Bonneville Power Administration, who spoke at the AWEA conference.

So it’s likely there will be plenty of room in the market for both utilities and private developers to build and own renewable resources. The problem may be not so much who builds but whether the needed capacity gets built. And while reliability is a strong worry, the consequences of failing to build an effective renewable energy economy may be even higher, warned Montana’s governor, Brian Schweitzer, addressing the AWEA conference: ‘Will you be the generation who weans our dependence on foreign oil. If you get it right, you will be known as the greatest generation. If you get it wrong, your grandchildren will be fighting a war somewhere else.’

Elisa Wood is US correspondent for Renewable Energy World

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