Wind could hedge against natural gas price spikes — study

Source: Umair Irfan, E&E reporter • Posted: Monday, March 18, 2013

It’s unlikely that natural gas will be cheap forever, so hedging against future price shocks with wind power could be a viable strategy for utilities in the United States, according to new research.

In a report released last week, Lawrence Berkeley National Laboratory researcher Mark Bolinger observed that wind power has a hard time competing on cost alone when natural gas prices bounce near a record floor. “It may need to fall back on its nonprice attributes,” he said in a conference call yesterday.

That means wind developers will have to emphasize their green bona fides while framing costs differently. Though electricity from wind may be more expensive than energy from a natural gas-fired generator, the cost of that power is usually constant.

Bolinger explained that developers build most wind farms under a power purchasing agreement (PPA), in which the utility agrees to buy electricity from turbine operators at a fixed price, typically for a decade or more. This price stability offers wind energy an advantage over volatile fuel prices, particularly for natural gas.

The study looked at commercial wind projects built between 1998 and 2012 using bundled PPAs, which served as a proxy for the levelized cost of energy by including energy prices and the value of renewable energy credits. “When I compare wind to gas, I want to be sure I’m counting the full revenue stream,” Bolinger said.

The sample covered 287 projects totaling 23,529 megawatts in capacity, roughly two-thirds of the wind capacity in the United States, and excluded presumed outliers like Alaska, Hawaii and Puerto Rico along with wind farms built using other financing mechanisms.

Of the analyzed projects, 84 percent of the capacity came from PPAs spanning more than 20 years. For the entire sample, electricity from wind averaged below $50 per megawatt-hour over the course of the purchasing contract.

Wind’s hedging power hinges on tax credit

Natural gas, on the other hand, is poised for an upswing. “The market believes there is more room for increases than decreases,” Bolinger said, noting that the gas futures market dries up only a couple of years into the future while physical gas supply deals expose utilities to a lot of risk and tend not to stretch beyond 10 years

This makes it hard for utilities to lock in a low price for natural gas and makes the present the ideal time to hedge, according to Bolinger. In this context, utilities should see wind as a fuel saver, displacing the natural gas that would otherwise be burned, rather than as capacity, he said.

Incorporating natural gas price projections from the Energy Information Administration, Bolinger found that wind would undercut natural gas electricity generation costs in several scenarios, such as a relatively low gas recovery rate from wells. This could happen as early as 2015, making wind a cost-effective way to insulate utilities from potentially volatile natural gas prices.

Without the production tax credit, however, wind would struggle as a hedging mechanism, though Bolinger maintains it would still provide value over the long term.

Some developers have already touted wind as a hedge, according to Bolinger. He cited Kurtis Haeger, the head of planning at the Public Service Co. of Colorado, who described wind energy as “an alternative fuel, with known contract pricing over 25 years that will displace fuels where the pricing is not yet known.”

Bolinger acknowledged that the study glosses over some of wind energy’s costs, like transmission, as well as its benefits, like zero emissions.

“This is by no means a comprehensive analysis,” he said, adding that this report is not entirely academic, either, so utilities should start investigating wind PPAs as part of their natural gas energy strategy.