Low-carbon energy an opportunity, not just a challenge
- July 20, 2014
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Renewable energy is growing rapidly. Non-hydro renewables now account for over 7 percent of U.S. electricity consumption—triple triple share from a decade ago. With falling costs and EPA’s new proposed rules poised to cut emissions from power plants, we can expect to see this growth continue into the next decade.
However, incorporating increasing amounts of renewable energy into the generation mix raises new challenges. One is how to mobilize cheap sources of finance to achieve this expansion at a reasonable cost. A second is how to deal with the variability of renewable generation—customers need reliable power even as the sun sets or the wind dies down. New business models could help utilities capitalize on the opportunities created by the need to meet these challenges. In our recent report, Roadmap to a Low Carbon Electricity System in the U.S. and Europe, we outline some of these.
Our analysis shows that newly emerging finance models can lower renewable energy costs by as much as 20 percent. How?
Compared with fossil energy, low-carbon energy has a very different investment profile: high upfront costs, but low operating costs, and, with long-term contracts, very low risk as it is not exposed to fuel price volatility. By splitting low-carbon energy finance off from traditional sources, renewables can appeal to a different class of investors looking for more infrastructure-like risks and returns.
Models that do just this are already emerging. Power producers and developers have begun to spin off their renewable energy assets into investment vehicles called YieldCos, which can attract low-cost capital by appealing to institutional investors such as pension funds and insurance companies, who manage over $71 trillion in assets. Prominent examples include NRG Yield, Greencoat Energy, Pattern Energy and the recently announced Nextera YieldCo.
However, further improvements could be made. For example, many YieldCos currently do not distribute all their earnings to shareholders, instead keeping some earnings to finance future investments. This leads to greater risk for shareholders and higher financing costs for energy. YieldCos that commit to financing future investments through capital markets rather than retained earnings could eliminate this premium and further bring down the cost of energy.
Another challenge—and opportunity—for utilities in a high renewable energy future will be maintaining system reliability. Our analysis suggests that keeping costs low and the lights on may mean that fossil fuel assets must be priced and valued mostly for their flexibility. During peak power times when renewables are off, fossil fuel sources can ramp up. This introduces a new opportunity for some utilities to provide generation during specific times along with the ramping and balancing services needed to balance renewable energy production.
Utilities can also more effectively address both the challenges outlined above by embracing a more active role of customers as resources and providers of services, not just as passive consumers. Customer generation and flexibility—for example, systems that allow customers to decide when to use more or less energy based on current prices or offer the batteries in their electric cars as a grid resource—have the potential to save the system billions of dollars, enabling greater penetration of low carbon energy and increasing system reliability.
As the electricity system transitions toward greater shares of renewable energy, utilities face huge challenges but also huge opportunities. New business and financing models, improved pricing structures, and the integration of energy management systems can allow utilities, consumers and new, innovative companies to work together to lower the cost and improve the reliability of the system as a whole.
Uday Varadarajan is a senior analyst at Climate Policy Initiative, which works to improve energy policies and has a particular focus on finance. Varadarajan was previously a program examiner in the Office of Management and Budget in the Executive Office of the President and oversaw the budget for the Department of Energy’s (DOE) energy efficiency and renewable energy programs.