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Is Wind Energy a Cost-Effective Hedge Against Rising Natural Gas Prices?

That’s the conclusion of a new report by researcher Mark Bolinger at the U.S. Lawrence Berkeley National Laboratory (LBNL). He’s done an enviable job of scouring public sources for wind energy supply contracts at the Federal Energy Regulatory Commission, state utility commissions and long-term power-purchase agreements in various wholesale markets.

This question is front-of-mind for wind energy professionals and advocates as they strive to articulate a economically sustainable path forward amid the boom in hydraulic fracturing of shale natural gas and the resulting low prices for it. Utilities facing renewable energy purchase requirements are likely plotting similar scenarios.

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This chart focuses only on the most recent wind power PPAs and shows how this limited, but current, sample competes with 3 natural gas price scenarios (black lines). The heavy blue line assumes continuation of the Production Tax Credit; the dashed-blue line above it puts wind’s price $28 per megawatt hour above it. CREDIT: Mark Bolinger, Lawrence Berkeley National Lab.

What if demand for gas grows even faster than predicted and prices start climbing sooner rather than later?

Just about all price risk for natural gas consumers is skewed upward. Enter wind energy as a reasonable hedge and a renewable one at that. In fact, this year might be a very good time to hedge, says Bolinger, who works in LBNL’s Environmental Energy Technologies Division.

The value proposition here is the ability of wind to deliver a stable-priced product over very long time frames.

Bolinger notes that locking in today’s low natural gas prices is not easily done, at least not without a certain cost. Even the upward sloping “futures strip,” as economists call it, it is hard to lock in long-term for any significant volume because trading is illiquid beyond the first few years.

Contracts for the physical gas deals are rare and even those deal only in short- or mid-length terms.

With the often uncertain future of the wind Production Tax Credit (PTC), this hedging strategy for wind just might breath some fresh energy into the industry that is looking at falling off yet another “cliff” when any new credits expire for projects that have not yet begun construction. Were the PTC to go away after this year with little chance of another revival, that could complicate the sustainability of this scenario. And it would certainly bump up its cost (see chart).

Among other complications is the softening in policy-driven demand for state renewable energy mandates. A few states are being challenged to halt further purchases of electricity from renewable sources, including Texas. There a boom in wind turbine installations helped the Lone Start State exceed its renewable energy requirement.

Bolinger’s sample draws on 287 power purchase agreements (PPAs) totaling about 23. 5 gigawatts between existing wind generators and electric utilities in the U.S. He compares them to contracted prices at which utilities will be buying wind power from these existing projects for decades to come to a variety of long-term projections of the fuel costs of gas-fired generation modeled by the Energy Information Administration (EIA).

Bolinger is hosting a webinar to elaborate and take questions this Thursday starting a 1 p.m. Eastern. You can register for it here. 

Here are comments illustrating the thinking of some bulk power purchasers as articulated by Google’s Ken Davis in a November 2011 issue of Project Finance Newswire.

“We see value in getting a long-term embedded hedge. We want to lock in the current electricity price for 20 years. We are making capital investment decisions [regarding data centers] on the order of 15 to 20 years. We would like to lock in our costs over the same period. Electricity is our number one operating expense after head count.”
 
“We are signing [conventional] contracts with three to five years of fixed pricing, but over the life of the data center, those will reset. We are short-term fixed and long-term floating, so it [wind] will not be a perfect hedge in the near term.
 
“We are less concerned about hedging our cash flows on a quarter by quarter basis. We are more concerned about the long term.”
 
“We are losing considerable amounts of money on every [wind] MWh [in the near term]. We just want to ensure the project is there in the later years.”
Jim Pierobon's picture

Thank Jim for the Post!

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Discussions

J Elliott's picture
J Elliott on Mar 13, 2013 3:57 pm GMT

How can wind power be a reasonable hedge against natural gas when variable wind power is not independent to natural gas and actually requires natural gas peaking power supply as a backup when the wind does not blow?  If wind power were also a reasonably economic hedge or off-set to natural gas power-costs why does it continue to rely on Government subsidies and various State mandated consumption standards for development and sustaining existing wind farm operations?  A recent Energy Collective post appears to indicate that recent natural gas power efficiency improvements are blowing away the economics of wind power.

Wilmot McCutchen's picture
Wilmot McCutchen on Mar 13, 2013 5:31 pm GMT

Wind needs to look for a new job that can accommodate its variability.  Something other than baseload generation.  Hoping for a miracle in storage before the next cliff is not realistic.  Pumping and grinding applications may not be as glamorous as "clean energy," but they could justify broad deployment of wind and don't have the grid connection problem.

Jim Pierobon's picture
Jim Pierobon on Mar 15, 2013 10:47 am GMT

Wilmot,

I think you nailed the challenge facing wind energy. We've got LOTs of company believing wind can be looked to for baseload generation. But in the middle third of the U.S. where wind is becoming cost-effective, utilities would be wise not to dismiss it as part of their generation mix if they're prudently assessing the risks of rising gas prices. 

~Jim Pierobon

Jim Pierobon's picture
Jim Pierobon on Mar 15, 2013 10:51 am GMT

"J":

Wind, like all other generation sources, wind is dependent on natural gas to meet all of the needs of a utility where wind is viable. But as part of that mix, it can help moderate the almost-certain increase in future natural gas prices in the middle third of the U.S. -- IF the Production Tax Credit remains for the next several years. 

~Jim Pierobon

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