# Presentation: 160408

## The Hedge Value of Renewable Energy

**Ryan H. Wiser**
- Lawrence Berkeley National Laboratory
- RHWiser@lbl.gov (510-486-5474)
- http://eetd.lbl.gov/ea/EMS/
- NREL Energy Analysis Forum
- Golden, Colorado
- November 9, 2004

## Motivation - To Enhance the Economic Value Proposition of Renewable Energy

***Historically**** –** *RE has been supported by policy and green marketing, with some vague connection to risk reduction benefits
***Now**** –** *It is possible to make the case for RE on economic grounds, by quantifying risk reduction benefits:
- Declining cost of renewables
- Increased wholesale price volatility (electricity and gas)
- Application of risk analysis and “portfolio theory”

- Renewable energy (RE) has attributes that can decrease certain electricity-sector portfolio risks

## The Hedge Value of Renewable Energy

- This presentation emphasizes the benefit of RE in reducing natural gas price risk, focusing on recent research by LBNL, and ends with a summary of additional research needs
- Renewable energy (RE) provides a hedge against volatile and escalating natural gas prices in two ways
**Mitigates Fuel Price Risk:** Unlike natural-gas-fired electricity generation, the cost of RE is not tied to the cost of natural gas
**Reduces Natural Gas Prices:** Increased RE reduces gas demand, and may consequently put downward pressure on gas prices

## Mitigating Fuel Price Risk

- Developing a base-case gas price forecast
- Analyzing uncertainty in the base-case gas price forecast
- Making cost-risk tradeoffs

## Developing a Base-Case Gas Price Forecast: It’s Not Easy!

- Base-Case Gas Price Forecasts Vary Substantially Across Western IRPs

## Developing a Base-Case Gas Price Forecast: Make Sure the Forecast Is Recent Because Expectations Are Changing

- EIA’s AEO Reference Case Forecasts Have Risen Consistently and Significantly Over Last 7 Years

## Benchmark Near-Term Gas Prices to NYMEX, which Arguably Represents Market’s Best Forecast of Prices

- Over last 4 years, forward gas prices have exceeded EIA reference case forecasts; gas price forecasts used by some utilities have also differed from 6-year NYMEX forward curve
- Use of gas price forecasts (rather than forwards) over this time period may have “biased” investment decisions towards variable-price gas-fired generation, and away from renewable energy
***When possible, use forward prices, not price forecasts, when comparing the levelized costs of gas-fired and RE generation***

## Analyzing Uncertainty in the Base-Case Gas Price Forecast

*National Petroleum Council (2003)*

**Do Not Place Great Emphasis on the **
**Base-Case Price Forecast!!!**

## Future Gas Prices are Highly Uncertain, and Forecasting Performance to Date Has Been Dismal

## Analysis Techniques for Evaluating Price Variability, and the Value of Different Resource Portfolios, Vary 

**Analytic Studies of the Costs and Benefits RE Deployment ***(e.g., national RPS, state renewable energy development, EERE R&D benefits analysis)*
- Have not begun to regularly use sophisticated analysis techniques
- Optimizing for “least-cost” in deterministic framework, with limited scenario analysis

- Analysis Techniques to Evaluate Price Variability and Value of Renewable Energy in Reducing Fuel Price Risk Have Improved, but Their Implementation is Uneven

- Deterministic analysis with only one gas-price forecast

- Scenario analysis with focus on base-case forecast

- Scenario analysis with more realistic assessment of probability of alternative futures

- Stochastic/ simulation analysis

**Utility Integrated Resource Plans **
- Increasingly using more sophisticated techniques (stochastic and scenario analysis)
- Wind increasingly viewed as an important part of a least-cost/low-risk portfolio

## Making Cost-Risk Tradeoffs

- Utilities are beginning to conduct sophisticated analysis of cost-risk tradeoffs, and selecting wind as part of the selected portfolio
- Little work conducted so far on how to appropriately make the tradeoff
- Little guidance from regulators or customers on risk management goals and expectations
- Can further research help answer this question?
- Should risk-adjusted discount rates be considered?
- Should customers be given a choice of portfolios with different risk profiles, including a lower-risk green power option?

## Reducing Natural Gas Prices

## The Impact of RE on Natural Gas Prices

- Increasing number of studies show that increased RE will reduce natural gas demand, placing downward pressure on gas prices
- While this price reduction is not strictly a gain in net social welfare, the effect is found to potentially be sizable enough to merit attention
- Recent LBNL research has sought to:
***Review economic theory*** to better understand the impact of natural gas demand reduction on natural gas prices
***Review previous modeling*** studies that have evaluated this effect, illustrating potential impacts of RE on reducing natural gas prices and consumer energy bills
***Compare the results*** of various modeling studies to each other, and to the economics literature, to test for consistency over time, across models, and with economic theory
***Determine whether*** existing models are treating this effect within reason, focusing on national impacts (regional impact analysis to come later)
***Develop a simplified method**** *for estimating the impact of RE investments on natural gas prices, without using a complex, integrated national energy model

## Key Findings of Our Review

- Many uncertainties remain, but central tendency of NEMS output is consistent with limited existing knowledge (e.g., other energy models, and empirical literature on historical elasticities)
- While a wealth transfer (and not a social gain), the effect of RE on gas prices is significant: **a** **reduction in gas bills due to RE could largely offset any expected incremental cost of RE **
- More thorough analysis is warranted; effect should be better integrated into RE cost and benefits analysis

- Models suggest that **1% drop in gas demand** could lead to **0.75% – 2.5% reduction in long-term wellhead prices**, with some models predicting larger effects

## The “External” Consumer Benefit of Renewable Energy

## Conclusions

- Gas prices are high, volatile, unpredictable, and diversification with RE can help hedge these risks
- Directly hedge gas costs
- Reduce gas consumption and prices
- More sophisticated risk analysis tools have the possibility of expanding the use of renewable energy
**Recent IRPs:** Those IRPs that have evaluated natural gas and carbon risks are now regularly finding that wind power is a beneficial contributor to a low-cost/low-risk portfolio
**Secondary Gas Impacts:** Studies of the impact of renewable energy on gas prices show potentially sizable benefits that may tip the scales in favor of renewable energy

## What Is Needed? 

- Apply more sophisticated risk analysis tools in assessments of the cost and benefits of renewable energy
- Utilize the techniques that are increasingly used in utility IRPs
- Develop better understanding of the range of plausible future gas prices
- Understand different hedging options and their limitations, and what risks renewable energy can and cannot hedge cost effectively
- Develop methods to quantify other risk benefits (and costs) of renewable energy, and popularize their use (e.g., risk of future environmental regulations)
- Develop tools to better address the tradeoff between the cost and risk of different resource portfolios
- Customer surveys of willingness to pay for price stability
- Develop more green power options that provide the benefit of price stability
- Generate a better understanding of the impact of RE on gas prices, focusing on the inverse price elasticity of gas supply

## Contact Information

**Ryan H. Wiser**
- Lawrence Berkeley National Laboratory
- 1 Cyclotron Road, MS 90-4000
- Berkeley, California 94720
- RHWiser@lbl.gov
- 510-486-5474
**Reports available at:**
- http://eetd.lbl.gov/ea/ems