# Presentation: 057599

## Valuing Renewable Generation AssetsHow Market Fundamentals and Regulations Drive Green Premiums 

- Chris MacCracken
- ICF Consulting
- July 10, 2003

## ICF Background

- Premier Power, Fuel, Air Emissions Model: The Integrated Planning Model (IPM®)
- NOX, SO2, Hg, and Carbon Market Assessments
- Multipollutant Asset Valuation and Market Impact Assessment
- Compliance Decision and Allowance Strategy Analysis
- Clean Energy Group Multipollutant Policy Analysis
- Allowance Allocation Analysis
- Renewable Analysis: RPS Analysis, and Renewable Investment Analysis

- Leading Power Market Consultant
- Generation Asset Due Diligence
- Lead consultant to EPA on Air Regulatory Analysis
- Acid Rain
- OTAG
- SIP Call
- Hg MACT
- Clear Skies
- Lead consultant to FERC on environmental impacts and transmission regulations
- Order 888
- Order 2000
- SMD

## Outline

- Value Components
- Drivers of Renewable Supply and Demand
- Representing Renewable Energy Supply and Demand in an Analytic Framework
- Creating Value: Current Regulatory Scenario - Renewable Market Forecast
- Valuing Renewable Generation

## Components of Renewable Generator Revenues

- DRAFT RESULTS

## Technological Change, Resource Constraints, and  Demand Growth Drive Renewable Price Trajectories

- The illustrative graph on the left represents how technological change, renewable resource constraints and renewable energy demand interact over time to determine equilibrium renewable energy prices.
- The marginal cost, or supply curve, of renewable power is made up of discrete steps, characterized by a quantity of available resource and a cost at which that resource is accessible.  Working up the supply curve, costs increase due to higher costs of development (e.g., more remote wind sites) and higher cost supply options (e.g., solar thermal).
- The curve shifts out over time as wind technologies achieve higher capacity factors at a lower up front capital cost.
- The rate of demand growth (i.e, high-versus-low in the chart) relative to technological advancement in renewable generation technology will shape renewable power prices over time.  This fact is illustrated in the difference between Pt+10HG and Pt+10LG.
- At high growth, demand outpaces the rate of technology advancement, leading to rising prices.  The opposite is true in the case of low demand growth.

- Where:
*D* = Renewable Energy Demand
-  *t* = year 1
*MC* = Marginal Cost (i.e., supply curve)
*LG* = Low Demand Growth
*HG* = High Demand Growth

**Intertemporal Renewable Supply and Demand Dynamics**

## Filling the Gap: REC Values Make Renewable Generators Whole

- The REC value will fill the gap between the levelized cost of production of renewable generators and other revenue sources shown on the previous page.
- The chart at left shows the levelized cost of production declining over time as a result of technological improvement and falling equipment costs.
- Sources of other revenue increase in this example.  Revenue from energy prices, increasing as a result of rising gas prices, multi-pollutant regulations or higher demand, could drive such a result.
- REC prices decline over time as the gap between the levelized cost and other revenues is squeezed by the factors mentioned above.
- As revenue rises and costs fall, a smaller amount of value is required from green power markets to make the renewable generators economic.
- By 2025 in this example, the REC market has collapsed as revenues from the energy and other markets are more than enough to justify development of new renewable capacity.

## Outline

- Value Components
- Drivers of Renewable Supply and Demand
- Representing Renewable Energy Supply and Demand in an Analytic Framework
- Creating Value: Current Regulatory Scenario - Renewable Market Forecast
- Valuing Renewable Generation

## Section Overview:  A Market in Regulatory and Economic Flux

- This section presents ICF’s views and reviews of key issues affecting renewable power generation and the markets that it supplies.
- Understanding the interplay of supply and demand factors for renewables in the context of historical green power premiums, gas and power markets, and air regulations is key to developing a sound view of the future value of renewable energy.
- ICF’s view of each of these regulatory and business trends is presented including how each factor is handled within ICF’s modeling framework (i.e., the assumptions we make).  The purpose of this section is to describe the key issues at play and to present ICF’s treatment of each factor in this study.

## Renewable Energy - A Growing Presence In Both Wholesale and Retail Marketplaces

- Renewable energy continues to be the fastest growing sector of the U.S. electric market.
- There are two key factors driving the increasing demand for green power:
**“****Grassroots” customer demand for green power**, based on customers desire to purchase energy with a reduced environmental impact relative to other sources.  This green power demand was responsible for almost 1,000 MW of new renewable capacity coming on-line through the end of 2002.
- Regulated markets – customer demand is met by utility green pricing programs.
- Deregulated/competitive markets – demand is met by green power marketers.
**Regulatory-driven Renewable Portfolio Standards (RPS)**, in which states require that a specific percentage of retail sales in that state come from renewable generation.
- Tradable renewable energy credits (RECs) have provided additional flexibility in green power markets.
- RECs are being marketed at both the retail and wholesale levels and are increasingly being used as the means of complying with state RPS regulations.

**Indexed Demand Growth Forecast***

- *2003 total estimated base national demand levels for energy from renewable power and total conventional power (national total less renewable-specific demand) indexed to 1.0 starting point.

## Green Pricing Trends in Regulated Markets

- In regulated markets, green pricing programs offered by utilities, intended to meet the grass-roots customer demand described above, continue to grow in number.
- More than 300 utilities in 32 states currently offer green pricing programs.
- Regulated utilities have installed almost 300 MW of new renewable capacity to meet the demand associated with these, with another 140 MW planned over the next year.*
- These programs represent the “traditional” green power market, where the idea of providing green power for a premium was first developed and tested.
- Residential customers were the early adopters, but commercial, institutional, and industrial customers eager to demonstrate their environmental stance to their customers and constituencies have generated increasing demand.
- Participation rates in the programs range from just under 6% of retail customers in some states to below 1%.

- *Information for capacity installed as a result of green power programs was derived from
- The Green Power Network – Estimates of Renewable Energy Developed to Serve Green Power Markets,
- http://www.eere.energy.gov/greenpower/

## Competitive Renewable Energy Offerings

- Green marketing is relatively strong in competitive markets, although the rollback of deregulation efforts has negatively impacted this sector.
- Competitive green power offerings currently exist in 11 states with 18 active retail marketers and 12 active wholesale marketers.
- Almost 700 MW of new renewable capacity has been built to supply competitive green power markets – at both the retail and wholesale levels – and another 290 MW of additional renewable capacity is planned.
- This does not include the capacity that has been installed to meet RPS requirements
- The vast majority of renewable capacity developed to supply competitive markets has come in the form of wind power due to its low cost (with the Production Tax Credit included) relative to other renewable sources and its marketability to consumers.

## Renewable Energy Credits Offer New Flexibility to Meet Green Power Demand

- RECs – also known as green tags or green certificates – disassociate the environmental benefit of green power from the actual generation.
- These credits can then be traded nationally, without the need to sign a power purchase agreement or establish a specific contract path.
- Consumers can purchase RECs to support renewable power development without switching to a new electricity supplier.
- Green power can be developed in areas where the resources are abundant (e.g., higher class wind regimes), without the necessity of a threshold demand for green power in the immediate vicinity.
- These factors have made RECs the mechanism of choice for meeting RPS requirements in a number of states.
- 11 organizations in the U.S. currently offer green energy certificate products, ranging from $12 - $40/MWh in price, with most prices ranging from $20 - $25/MWh.
- It is difficult to discern from the retail prices shown the underlying green premium required by the “overmarket” renewable resource from the standard retail margin.  The prices are indicative, however, both of what the market for renewable energy will bear and the premium necessary to encourage the development of new renewable resources.

## Renewable Portfolio Standards In-Place In Many States, Proposed at Regional and National Levels

- 14 states already have renewable portfolio standards (RPS) in place and several others have been proposed.

- In the last Congress, the U.S. Senate proposed amendments to the House of Representative’s Energy Policy Act of 2002 (H.R.4). Senate bill S.1766 requires a defined percentage of retail electric supply that must be generated from renewable energy sources.  The percentage requirements begin at 2.5% in 2005 and grow to 10% by 2020.  The future of a national RPS in a future national energy bill is highly uncertain.
- Renewable portfolio standards are also being considered on a regional basis.  For example, the Grand Canyon Visibility Transport Commission (GCVTC) has proposed a multi-state renewable portfolio standard. In the upper Midwest, the Environmental Law and Policy Center has issued a report calling for an RPS of 8% in 2010 growing to 22% by 2020.

## Technology, Viable Resources, Financing and Development Activity Shape the Supply-Side Story

| Renewable Resource Availability | Tremendous uncertainty surrounds the total economic wind resource base.  The limits on regional wind power development will drive future renewable markets, determining both equilibrium REC prices and the renewable build mix. |
| --- | --- |
| Renewable Technological Advancement | Technological change is the key factor offsetting renewable resource constraints over time.  While significant change is inevitable, future costs and performance of renewable technologies, particularly achievable wind capacity factors, are highly uncertain. |
| Existing, Firm, and Proposed Renewable Capacity | Many developers are racing to capture the wind production tax credit (PTC) prior to it expiring on December 31, 2003.  As more capacity comes on line, anticipate potential soft spots in renewable markets due to excess supply and increases in the rate of technological advancement. |
| Renewable Plant Financing Costs and Wind PTC | Today the financial carrying cost of wind is dramatically lower than conventional technologies.  If the wind PTC or rules allowing accelerated renewable depreciation are repealed, expect a dramatic increase in renewable premiums. |
| Transmission Access and Siting Challenges | Many wind sites are miles from transmission or offshore, potentially doubling the costs of some wind resources.  If demand for renewable energy rises rapidly, expect transmission cost increases to more than out step technological change. |

## Overview of Supply-Side Dynamics in Renewable Markets

- The supply of renewable resources remains uncertain—complicated by a number of factors including resource estimates, technological advancement, siting/transmission, taxes, and financing.
- Most analysts still rely on the Department of Energy’s Energy Information Administration (EIA) for a comprehensive assessment of wind resources in the U.S.  While comprehensive, a variety of criticisms have been made of the estimates, and the industry awaits an up-to-date recalculation of national wind resources.  In this analysis we use EIA as a starting point and run scenarios around the resource estimates to bracket the range of future outcomes.
- On the technology side, the range of estimates is narrowing and the majority of debate surrounds the rate of technological change and how high capacity factors can go.  The assumptions used herein represent a reasonable middle-ground.
- In the near-term, one of the key determinants of REC prices is the amount of capacity currently on-line or under construction that will be available to meet impending RPS requirements.
- Taxes, siting, and financing issues all have additional implications for the supply of wind and are discussed at greater length later in this report.
- The following slides detail the supply-side assumptions used in this analysis.

## Modeling Wind Resources in IPM®

- Wind resource availability by region is based on DOE/EIA assumptions used in their Annual Energy Outlook 2002 projections.  Wind energy resources are dependent on geographic location, as certain areas of the country have stronger and more consistent wind patterns than others.
- In addition, because wind resources are located across various terrains (remote mountain ridge tops, agricultural fields, shore lines, etc.), resource degradation factors are applied to new wind plants to account for differences in site improvement and right-of-way/access costs.  Wind resources are divided into three cost adjustment categories to account for these differences in IPM®:
- Step 1: The first block of wind capacity additions (up to a specified regional capacity limit) is assumed to be built at base cost (base cost multiplied by 1)
- Step 2: After the maximum capacity for each region in Step 1 is built, the base capital cost for new wind resources is increased by 20 percent (base cost multiplied by 1.2)
- Step 3: Similarly, after the maximum capacity for each region in Step 2 is built, new wind capacity is built at a capital cost that is 50 percent higher than the base cost
- The cost adjustment factors above are based on DOE/EIA assumptions for modeling wind energy, which includes a total of 5 cost adjustment steps*.  In order to practically model this step function within IPM®, we have condensed the first four of EIA’s cost steps into the above 3 steps.   EIA’s fifth step is not included in IPM® because it represents resources that are not economically accessible until after 2020. The capacity bounds for each model region and step category are included in the following slide.

- **Modeling the Costs of U.S. Wind Supply*, Thomas Petersik, EIA, Issues in Midterm Analysis and Forecasting, Table 5, 1999.

## Wind Development Activity, By RPS Region (MW)

- If the firmly planned and proposed projects proceed, installed wind capacity in 2004 will exceed today’s nearly 4.8 GW level by 60%.  Planned units are assumed to be under construction, proposed units are still in the permitting phase.
- The 2003 and 2004 projects coincide with regions facing RPS policies.

## Renewable Resource Potential, By RPS Region (MW)

- *Iowa & Wisconsin figures include the resource base of 5 additional states, including Minnesota, North Dakota, South Dakota, Nebraska, and parts of Montana.

## Cost and Performance of New Renewable Power Technologies

- Note: Data in the above table is derived from a range of resources, including ICF industry analysis, and EIA’s AEO 2003.

## All-in Generation Costs Vary Widely by Renewable Technology

- The table below shows the cost components assumed in this study and the resulting levelized cost of generation by technology.
- Please note that these numbers do not reflect regional cost adjustments.

## A Production Tax Credit for New Wind Capacity is Assumed Through 2020 

- Currently, the Federal Production Tax Credit (PTC) is valued at roughly $18/MWh (2003$) and is available to new wind projects that are installed and operational by the end of 2003.  Eligible projects can receive the tax credit for up to 10 years.  Although the PTC is set to expire after 2003, various environmental groups and members of the wind industry are pushing for an extension beyond 2003 to further support wind development in a competitive market.
- ICF assumes that a PTC for new wind units is continually renewed through 2020.  This effectively reduces the levelized cost of generation for new wind plants built by the model.
- The effective subsidy provided by the PTC is the $18/MWh rate for 10 years levelized over the assumed 20-year lifetime of a wind project.
- The $10.71 figure shown in the above table reflects that levelized cost.

## Factors Affecting Power Prices Directly Affect The Value of Renewable Markets and Assets

- The two most significant factors affecting future wholesale power prices are:
- Gas market uncertainty and volatility.
- Multi-pollutant regulations affecting NOX, SO2, Hg, and CO2.
- Since renewable markets produce a blended commodity of green attributes and electric power, factors affecting power markets will also affect renewable markets and assets.
- As has been discussed previously, green premiums or REC prices are set by the difference between the all-in cost of renewable generation and the wholesale power prices.  Therefore, when power prices go up, REC prices will go down.
- Similarly, if the market anticipates that multi-pollutant regulations will drive up future power prices, REC prices may be depressed now, since companies would be banking on future returns.

## Key Air Policy Proposals

| Group | Sponsor(s) | Policy Stringency & Timing |  |  |  | Key Provisions |
| --- | --- | --- | --- | --- | --- | --- |
|  |  |  Annual NOX(million tons) | Annual SO2(million tons) | Annual Hg (tons) | Annual CO2(million tons) |  |
| 2000 Electric Generation Emission comparison |  | 5.1 million tons | 11.2 million tons | 48 tons | 2,492 million tons |  |
| Clear Skies Act of 2003 | Bush Admin.,SenatorsInhofe (R-OK),Voinovich (R-OH) | 2.1 in 2008
1.7 in 2018 | 4.5 in 2010
3.0 in 2018 | 26 in 2010
15 in 2018 | Voluntary |  Option to recalculate caps in 2018
 Backstop prices for SO2, NOX & Hg
 Transition to auction by year 2060
 East/West NOX Trading Zones |
| Clear Air Planning Act of 2002 | SenatorsCarper (D-DE), Chafee (R-RI), Breaux (D-LA), Baucus (D-MT) | 1.87 in 2008
1.70 in 2012 | 4.45 in 2008
3.00 in 2012
2.25 in 2015 | 24 in 2008
5 - 16 in 2012
At facility, more stringent of 50% or 4lb/TBtu in 2008(2012 TBD) | 2005 levels in 2008
2001 levels in 2012 |  Includes NSR Reform
 3-yr. generation-based updating      allocations for NOX, CO2 (including incremental nuclear and new renewables) and mercury
 Extensive flexibility to meet CO2 cap cost-effectively |
| McCain-Lieberman Global Warming Proposal | SenatorsMcCain (R-AZ), Lieberman (D-CT) | N/A | N/A | N/A | 2000 levels in 2010
1990 levels in 2016 | Regulation would affect multiple sectors of economy, including electric generation
Cap and trade approach |

## State Air Regulatory Actions Threaten to Balkanize Emissions Markets

- The “Action” states highlighted in the map have already implemented or are in the process of developing multi-pollutant air regulations.
- Growing state regulatory action could have a dramatic impact on allowance prices and the economics of control decisions.
- Several of the state regulations include CO2 emission restrictions in addition to caps on NOX, SO2 and Hg.

## Outline

- Value Components
- Drivers of Renewable Supply and Demand
- Representing Renewable Energy Supply and Demand in an Analytic Framework
- Creating Value: Current Regulatory Scenario - Renewable Market Forecast
- Valuing Renewable Generation

## IPM® Analytic Framework

## IPM® Layers Rich Detail of Renewable Supply and Demand into the Broader Power Market Specification

_***Demand***_

_***Supply***_

## Reference Case Regional Renewable Market

**Reference Case Regional Renewable Market**

**CA/NV Market**

**Arizona Market****

**Texas Market**

**Iowa/Wisconsin Market**

**PJM Market **

- *State percentage labels refer to assumed RPS levels for years 2003 & 2010 as a percent of state retail sales.
- **Arizona and New Mexico may export but not import RECs to/from other states.
*******All States without an RPS standard are assumed to have background green power demand of 0.5% in 2005 growing to 1.0% in 2020.

**New England Market **

**10% - 17%**

**5% - 11%**

**0.5% - 1.5% **

**0.6% - 1.1%**

**2% - 10%**

**30% - 30%**

**1% - 5%**

**0.07% - 0.1%**

**New Mexico Market****

**NY Market **

**0.9% - 1.9% **

**2% - 2% **

**18% - 25% **

**2% - 4% **

**3.3% - 5.5%**

## Outline

- Value Components
- Drivers of Renewable Supply and Demand
- Representing Renewable Energy Supply and Demand in an Analytic Framework
- Creating Value: Current Regulatory Scenario - Renewable Market Forecast
- Valuing Renewable Generation

## Renewable Capacity Additions (Cumulative MW)Reference Case

**EAST**

**CENTRAL**

**WEST**

- * Geothermal capacity includes both construction at new sites and upgrades to existing facilities.

## Renewable Annuity Contract Projections ($/MWh) Reference Case

- Charts reflect average for renewable energy 20-year annuity contracts in each region, i.e., “East” price trajectory represents the demand-weighted average of annuity payments in PJM, New York, and Massachusetts markets.

**EAST**

**CENTRAL**

**WEST**

## Key Drivers of REC Prices

**Impact on Value of Renewable Energy Credits**

## Outline

- Value Components
- Drivers of Renewable Supply and Demand
- Representing Renewable Energy Supply and Demand in an Analytic Framework
- Creating Value: Current Regulatory Scenario - Renewable Market Forecast
- Valuing Renewable Generation

## Components of Renewable Generator Revenues:Energy Revenue

- DRAFT RESULTS

## Components of Renewable Generator Revenues:Energy and Capacity Revenue

- DRAFT RESULTS

## Components of Renewable Generator Revenues:Total Renewable Revenue

- DRAFT RESULTS

## Components of Renewable Generator Revenues:Energy Revenues under Multi-P Regulations

- DRAFT RESULTS

## Components of Renewable Generator Revenues:REC Market Revenues under Multi-P Regulations

- DRAFT RESULTS

## Components of Renewable Generator Revenues: Total Renewable Revenue under Multi-P Regulations

- DRAFT RESULTS

## Components of Renewable Asset Value

## For More Information

- Chris MacCrackenManager703-934-3277cmaccracken@icfconsulting.com