Reducing emissions at a lower cost with new business models
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This document summarizes strategies for reducing emissions from the power sector at lowest cost. It discusses how new business models and policies can make clean energy the lowest cost solution by reducing financing costs. Specifically, it analyzes how long term contracts and policies that reduce risk can lower the cost of renewable energy by 5-15% by attracting lower cost financing. It also discusses how policies can minimize stranded fossil fuel assets and system costs as the grid transitions to more clean energy through approaches like implementing a separate market for renewable energy.
Reducing emissions at a lower cost with new business models
- 1. 1 235 Montgomery St. 13th Floor San Francisco, CA 94104, USA climatepolicyinitiative.org BRAZIL CHINA EUROPE INDIA INDONESIA SOUTHERN AFRICA UNITED STATES Reducing Emissions at Lower Cost with New Business Models Uday Varadarajan
- 2. 22 CPI brings a finance perspective to evaluating policy options for reducing carbon emissions We use financial and market models to address questions such as: • How can my state deploy clean energy sources at the lowest financing cost? • How much stranded power plant value does my state risk in the coming transition? How can states minimize stranding risk and best make use of existing electricity assets in a low-carbon electricity system?
- 3. 33 Challenge: Reducing CO2 emissions in the power sector at the lowest cost Four “building blocks” suggested by EPA: Many suggested strategies(especially blocks 1 and 2) work at the margin of the existing system. Our analysis shows that states can see greater cost savings by making a long-term commitment to clean energy. Improve fossil fuel plant efficiency Switch from coal to gas Renewable energy Energy efficiency Our focus
- 4. 44 New business models – with help from policy – can make clean energy the lowest-cost solution
- 5. 55 Clean energy is capital-intensive, so financing costs have an outsize impact on cost of electricity Breakdown of lifetime costs for new power plants (Data source: EIA)
- 6. 66 Reducing policy-related risk is critical to unlocking low-cost financing Policy Barrier Impact on Cost Solutions Duration of Revenue Support 10-year vs. 20-year contract RPS with long-term targets Public authority as counterparty / intermediary Revenue Certainty Electricity sales subject to market price risk Pull contracted renewables out of spot market PPA/feed-in tariff with price collar or minimum price Risk Perception: Equity Higher cost of equity Clear commitment to consistent policy direction: Good state policies can help overcome history of fluctuating tax credits Risk Perception: Debt Higher required debt coverage Completion Certainty 1-year construction delay Simplify planning and permitting processes Cost Certainty 5% cost overrun Limited control by policymakers 0% 5% 10% 15% Increase in Cost of Electricity (Added financing cost as % of total cost without subsidy)
- 7. 77 Investors in IOU / IPPs are looking for greater risks and returns than renewable energy projects offer; this raises financing costs for renewables Typical Renewable Energy Project Characteristics Typical IOU / IPP Investment Profile Cash flows High upfront capital costs followed by small ongoing costs; output relatively fixed as will be price and income (depending on regulation) Moderate upfront capital costs followed by significant maintenance, operating and fuel expenses over project life; income varies depending on dispatch and energy prices Opportunities for outperformance Relatively limited, particularly with feed-in tariffs or fixed-price contracts Several, including fuel contracting, energy trading, operation, availability and efficiency improvement Risk Limited; some regulatory and performance risk Beta can be 0 with appropriate regulation Moderate, including fuel price, dispatch, market demand, regulation Beta ~ 0.5 – 1.0 or higher Return Should be low, as lower risks and predictable cash flows are more analogous to corporate bonds than equity Moderate, justifies equity-type returns to manage risks and provide incentives for outperformance Growth Limited at the project level, unless the tariffs or contracts have indexation provisions Moderate, as natural fuel price inflation and performance and availability enhancement could lead to growing revenues
- 8. 88 Clean energy is a much better fit for investors seeking low-risk, long-term investments Ownership model Policy approaches Examples Institutional investors RPS with long-term targets Contracted renewables not subject to spot market prices Public authority as counterparty / intermediary in competitive markets Greater Sandhill (CO) Catalina Solar (CA) Mountain Wind (WY) Municipalities and state governments Build renewable energy as public infrastructure with state or local bonds (including “green bonds”) Conduit bonds for non-government entities Direct ownership by municipal utilities or public authorities Connecticut Green Bank Southern California Public Power Authority Energy customers Less data/experience to draw on Options include virtual net metering, green power programs, community renewable energy programs, opening markets to behind- the-meter resources Minnesota community solar
- 9. 99 NY Example: 20-Year PPA Can Cut Cost for Wind by $12/MWh; Utility-Owned Generation by $6/MWh • Results from NYSERDA (2015) “Large-Scale Renewable Energy Development in New York: Options and Assessment” • No PTC extension assumed • Premium is relative to discounted NYISO CARIS projected market prices
- 10. 1010 NY Example: If the PPA enables YieldCo financing, this benefit could increase to $14-15/MWh • Results from NYSERDA (2015) “Large-Scale Renewable Energy Development in New York: Options and Assessment” • No PTC extension assumed • Premium is relative to discounted NYISO CARIS projected market prices
- 11. 1111 Utility-ownership more expensive as revenue requirements high early & decline with depreciation NOTE: With operating expenses well under half of projected market prices at the end of 20 years, EDC ownership has the potential up-side of providing terminal value at relatively low costs.
- 12. 1212 The lowest-cost strategy for each state depends on its starting point Vertically integrated Competitive Investor- owned Publicly owned Investor- owned Publicly owned Low High Low High Building renewables may make sense before restructuring Restructuring can lower financing costs for both fossil and renewable generation Take advantage of low financing costs to build and own renewables Building more in-state RE can help state retain its generation market share Decision to build vs. buy depends on where the best untapped resources are Conduit bonds, securitized debt can be a route to low-cost financing Market structure Utility ownership RE % today Solutions (initial hypotheses; dotted lines require more analysis)
- 13. 1313 Market structures and priorities will need to change in a system with more clean energy Energy, 74% Capacity, 12% Ancillary Services, 3% Transmission and Grid Operation, 11% Breakdown of wholesale energy costs in PJM market (2012) In a system dominated by clean energy with zero fuel cost, timing and flexibility will be more important Current markets are driven by fuel and other operating costs
- 14. 1414 State-level policy options to reduce the risk of stranding fossil fuel power plants
- 15. 1515 Stranded asset risk is real, but can be minimized with good policy/regulatory choices In an electricity system with high renewable penetration, resources that can provide flexible power will be more valuable – Today, most markets do not price flexibility – Pulling inflexible low-carbon generators (renewables, nuclear) out of real-time markets provides a better price signal to flexible generators – For RTOs, collaboration among states will be needed to change markets Many of the most polluting plants are old — important to avoid new investment in plants that will soon become uneconomical
- 16. 1616 A separate market for renewables could allow flexible fossil fuel plants to remain viable with high renewable energy penetration -$50 $0 $50 $100 $150 $200 $250 $300 0 2000 4000 6000 8000 LBMP($/MWh) Hours Single Energy Market -$50 $0 $50 $100 $150 $200 $250 $300 0 2000 4000 6000 8000 LBMP($/MWh) Hours $16 / kW-Year Flexibility Value Added $41 / kW-Year Flexibility Value Added Modeling a sample of power plants in New York: 10% RE 50% RE 50% RE 10% RE Average electricity price 10% RE $51/MWh 50% RE $32/MWh Average electricity price 10% RE $52/MWh 50% RE $54/MWh Renewables in Separate Market
- 17. 1717 Profitability of a highly flexible and efficient gas turbine: Single electricity market Renewables in separate market 10% RE 50% RE 10% RE 50% RE Annual profit Capacity factor 66% 28% 66% 34% $4.6 million $4.1 million $5.7 million $6.5 million
- 18. 1818 Stranding / Flexibility Example: Indiana & 111(d) Generation Mix: ISOs: MISO and PJM Territories EPA Proposed 2030 Target: 23% reduction in CO2 emissions/MWh Implementation Scenario 1 Inside-the-fence, rate-based standard shuts down the least efficient coal facilities; 4% generation from renewables enters existing market Implementation Scenario 2 Renewable portfolio standard set at 12%; energy efficiency reduces load; renewables do not participate in hourly electricity market In each implementation scenario, system reliability is maintained by matching supply and demand on an hourly basis Coal 81% Natural Gas 13% Oil 1% Wind 3% Other - Renewable 1% Other - Non-renewable 1% PRELIMINARYANALYSIS:INDIANA Indiana in 2012
- 19. 1919 Lowest net cost option does not close all coal plants – instead, it values them to provide flexible power to a grid with more clean energy Scenario 1: Rate- based standard, add 4% RE to market Scenario 2: 12% RPS, renewables in separate market Fossil Renewable Fossil Renewable Capital costs + $76 + $64 + $271 + $383 Operating costs – $377 + $40 – $784 + $240 Financing costs + $1,334 + $35 + $375 + $208 Net impact on costs +$1.1 billion +$700 million (41% lower) PRELIMINARYANALYSIS:INDIANA Change from baseline through 2030 ($millions):
- 20. 2020 -$1,500 -$1,000 -$500 $0 $500 Coal Gas (GT) Gas (NGCC) Net value at risk PRELIMINARYANALYSIS:INDIANA Scenario 2: 12% RPS, RE in separate market Net Value at Risk in 2030: $650 million Scenario 1: Rate-based standard, add 4% RE to market Net Value at Risk in 2030: $1.4 billion An RPS and separate market for renewables could reduce value at risk by more than 50%
- 21. 2121 About CPI Climate Policy Initiative (CPI) works to improve the most important energy and land use policies around the world, with a particular focus on finance. CPI’s Energy Finance program works with governments, utilities, companies, banks, investors, and foundations around the world to understand the true cost of the transition to a low- carbon energy system, to evaluate and improve policy, and to design new financial vehicles that can lower costs and align investment returns from low-carbon energy assets with investors’ needs. www.climatepolicyinitiative.org Contact: [email protected]