Mark J Skowronski - Markron Technologies LLC
31.07.09
meant to “jump start” the industry but will not necessarily permanently sustain the industry. In addition, there are also certain hidden “best choice” discriminations against renewables that may not always be immediately recognized, but, nevertheless, may substantially inhibit the deployment of renewable energy. In order to provide a fully sustainable energy future for our children, tax policies must not only be changed to recognize the differences between renewable energy and conventional fossil energy, but certain non-fiscal “best choice” and other “nuances” that discriminate against renewable energy investments must also be recognized and corrected.
Renewable “Fuel” Risk to the Investor Owned Utilities (IOU)
The largest purchaser of renewable energy will inevitably be the nation’s IOU’s. These institutions have a long established record of conservatism that is a result of the structure that the regulatory commissions have imposed upon them. In essence, most risk taken by the IOU is born by the shareholder but most economic gain resulting from the risk is normally tallied to the ratepayer. Consequently, the IOU’s undertake little risk. The concept of “used and useful” is a primary factor in determining those investments that are rate based by the regulatory commission. Certainly, if a poor investment is made that results in a generation asset that is not “used and useful” it is doubtful that the investment will be allowed an authorized rate of return by the commission. The IOU is therefore incentivized to invest only in capital assets that have little risk of failure. The fuel cost incurred by the IOU is normally recognized as a non-capital liability and is typically a “pass through” expense that the IOU collects from the ratepayer. The net result of this IOU financial structure is the IOU’s only have risk for capital (and this is for only capital investment that the IOU’s assume is nearly risk free through proven performance) and have no capital risk for fuel purchase.
Since fuel prices tend to be difficult to forecast and have high volatility, the concept is that the IOU negotiates in good faith with the fuel supplier and passes all fuel expenses to the ratepayer with some sort of balancing account at planned intervals to “true up” the cost incurred and revenues received. The net result is that there is no IOU risk in the purchase of fossil fuel. This puts renewables at a distinct disadvantage when the investment is evaluated from a risk perspective. This is due to the fact that the renewable “fuel” is, essentially, capitalized, and the IOU incurs risk under the “used and useful” criteria used by the regulatory commissions to establish whether or not the investment is allowed into the rate base. As noted, the IOU’s typically are prone not to invest in renewables due to its limited performance history compared to fossil alternatives and the utilities’ inherent avoidance of risk; adding the capitalization of the fuel only exacerbates the amount of risk incurred by the IOU when building renewable energy plants.
As an example, lets say an IOU is evaluating an investment in solar energy or a combustion turbine (CT) to help meet its peaking load. Depending on assumptions, primarily future fossil fuel costs, a present worth cost evaluation may show that the cost to the utility is the same for both alternatives on an “all-in” cost base that is levelized over, say, 25 years. The solar installation could cost upwards of ~$5,000/kW (installed cost of PV) compared to an installed cost of a CT of ~$1,000/kW. The IOU would assume a “used and useful” capital cost risk of $5,000 for the solar versus $1,000 for the CT option notwithstanding that the levelized costs of each option are the same. The IOU has no risk for the cost of the fuel used for the CT as this is expensed and passed through to the ratepayer. One might argue that the solar option provides future price guarantees compared to the CT, however, there is no economic compensation to the IOU for this “guarantee” and, as such, does not enter into the economic decision with regard to which option to chose. The utility would tend to pick the least risk option, i.e. fossil generation.
Coupled with an incomplete operating history of many high tech renewable energy options, the “capitalization” of fuel, and the inherent risk of capital imposed on the IOU by the regulatory commissions, there is little incentive for an IOU to chose “green” even when the “green” alternative achieves cost parity with fossil generation. This concept of capitalizing the fuel is also manifested in Power Purchase Agreements (PPA). The fuel component is, of course, part of the renewable PPA and these contracts are deemed to be “debt” by the financial community. Consequently, there is an overall debt to equity impact to the IOU resulting from renewable energy purchased under a PPA. This debt to equity impact on bond rating is explicitly acute when dealing with solar energy as these types of PPA’s provide high cost premium “on-peak” energy to the IOU’s. In other words, a solar PPA may provide the same amount of energy as a geothermal PPA but, obviously, would result in higher overall PPA cost due to the higher value product and thus have a higher (and negative) impact on the utilities’ bond ratings
Conclusions
The IOU risk associated with the capitalization of renewable “fuel” and the type of renewable “fuel” needs to be recognized by the regulatory commissions. The IOU’s must be compensated for the greater risk of capital incurred and the lower bond ratings that may result in choosing “green” alternatives.
Renewable “Fuel” Risk to the Investor Owned Utilities (IOU)
The largest purchaser of renewable energy will inevitably be the nation’s IOU’s. These institutions have a long established record of conservatism that is a result of the structure that the regulatory commissions have imposed upon them. In essence, most risk taken by the IOU is born by the shareholder but most economic gain resulting from the risk is normally tallied to the ratepayer. Consequently, the IOU’s undertake little risk. The concept of “used and useful” is a primary factor in determining those investments that are rate based by the regulatory commission. Certainly, if a poor investment is made that results in a generation asset that is not “used and useful” it is doubtful that the investment will be allowed an authorized rate of return by the commission. The IOU is therefore incentivized to invest only in capital assets that have little risk of failure. The fuel cost incurred by the IOU is normally recognized as a non-capital liability and is typically a “pass through” expense that the IOU collects from the ratepayer. The net result of this IOU financial structure is the IOU’s only have risk for capital (and this is for only capital investment that the IOU’s assume is nearly risk free through proven performance) and have no capital risk for fuel purchase.
Since fuel prices tend to be difficult to forecast and have high volatility, the concept is that the IOU negotiates in good faith with the fuel supplier and passes all fuel expenses to the ratepayer with some sort of balancing account at planned intervals to “true up” the cost incurred and revenues received. The net result is that there is no IOU risk in the purchase of fossil fuel. This puts renewables at a distinct disadvantage when the investment is evaluated from a risk perspective. This is due to the fact that the renewable “fuel” is, essentially, capitalized, and the IOU incurs risk under the “used and useful” criteria used by the regulatory commissions to establish whether or not the investment is allowed into the rate base. As noted, the IOU’s typically are prone not to invest in renewables due to its limited performance history compared to fossil alternatives and the utilities’ inherent avoidance of risk; adding the capitalization of the fuel only exacerbates the amount of risk incurred by the IOU when building renewable energy plants.
As an example, lets say an IOU is evaluating an investment in solar energy or a combustion turbine (CT) to help meet its peaking load. Depending on assumptions, primarily future fossil fuel costs, a present worth cost evaluation may show that the cost to the utility is the same for both alternatives on an “all-in” cost base that is levelized over, say, 25 years. The solar installation could cost upwards of ~$5,000/kW (installed cost of PV) compared to an installed cost of a CT of ~$1,000/kW. The IOU would assume a “used and useful” capital cost risk of $5,000 for the solar versus $1,000 for the CT option notwithstanding that the levelized costs of each option are the same. The IOU has no risk for the cost of the fuel used for the CT as this is expensed and passed through to the ratepayer. One might argue that the solar option provides future price guarantees compared to the CT, however, there is no economic compensation to the IOU for this “guarantee” and, as such, does not enter into the economic decision with regard to which option to chose. The utility would tend to pick the least risk option, i.e. fossil generation.
Coupled with an incomplete operating history of many high tech renewable energy options, the “capitalization” of fuel, and the inherent risk of capital imposed on the IOU by the regulatory commissions, there is little incentive for an IOU to chose “green” even when the “green” alternative achieves cost parity with fossil generation. This concept of capitalizing the fuel is also manifested in Power Purchase Agreements (PPA). The fuel component is, of course, part of the renewable PPA and these contracts are deemed to be “debt” by the financial community. Consequently, there is an overall debt to equity impact to the IOU resulting from renewable energy purchased under a PPA. This debt to equity impact on bond rating is explicitly acute when dealing with solar energy as these types of PPA’s provide high cost premium “on-peak” energy to the IOU’s. In other words, a solar PPA may provide the same amount of energy as a geothermal PPA but, obviously, would result in higher overall PPA cost due to the higher value product and thus have a higher (and negative) impact on the utilities’ bond ratings
Conclusions
The IOU risk associated with the capitalization of renewable “fuel” and the type of renewable “fuel” needs to be recognized by the regulatory commissions. The IOU’s must be compensated for the greater risk of capital incurred and the lower bond ratings that may result in choosing “green” alternatives.
Your Comment
Ernst Ligteringen - The Global Reporting Initiative
31.07.09
The first point to make is that if anything we owe it to future generations to do more to increase their chances of living well on a more crowded planet. The second point is that there is a lot we can do; too often we can become tempted to accept defeat, to lose hope, to think that the task is too great, the sacrifices required impossible. The problem is that often we don’t know where to start.
We do have a general idea of what a sustainable future looks like, but, we need to know how to get there; how to meet the needs of present generations...
The way we produce the things we need, and the kind of products and services that are sold is a major factor in our sustainability. Unfortunately the way in which many companies communicate – through marketing, annual reports and other vehicles - leaves us clueless about the effects they currently have on, for example, climate change, inequality, resource use or effluents and waste. We have no idea where they are now in relation to the pressing sustainability issues of today and how they plan to navigate through to a sustainable future. They often have no idea themselves. Consequently we don’t have a good idea of the effects of many small and big decisions we make when we buy things, invest, and chose what to do in our professional lives.
Transparency on environmental and social issues, as well as impact on the broader economy, is thus necessary if we are to find our starting point on that journey to a sustainable future.
Of course, just as geographical positioning coordinates are, by necessity, standardized, so it must be with our sustainability disclosures. We need a common framework for sustainability disclosure, a common set of metrics devised to ensure our transition to a sustainable common future. It is the mission of the Global Reporting Initiative to bring diverse groups of individuals – stakeholders in our common future – together to set out the principles and indicators that organizations can use to measure and manage their sustainability performance.
Not only does reporting allow for the benchmarking of companies – crucially allowing people, whether as employees, investors, consumers or other stakeholders to make informed choices, but it helps effect change from within. For example, knowing exactly what a company’s carbon emission are, in relation to others in its industry, enables it to work out ways to reduce them and knowing the labor policies in its supply chain enables it to improve them. It can lead to a virtuous circle.
In a sustainability report a company can share with us how, in its thinking and in its actions, it is rising to the challenges posed by the sustainability crisis and how it expects to navigate towards a future in which generations to come will be free to live well on a planet of nine billion people.
Yet it is still a minority of companies globally – albeit a sizeable one – who issue reports on their sustainability performance. This isn’t good enough. The stakes are just too high. For this reason the Board of Directors of the Global Reporting Initiative recently published The Amsterdam Declaration on Transparency and Reporting in which it called for governments to require companies to report or explain whey they will not report on their sustainability performance.