Stuck in the Past: Old Models Stymie Clean Energy Transition

With the upcoming COP 24 session in Poland, I recently published a post that looks at the progress that has been made since COP 21. COP 21 is when we saw the drafting of the Paris Agreement. COP 24 is the opportunity to truly put together implementation strategies for countries to meet their greenhouse gas reduction goals. There are several market sectors that are impacted by the Paris Agreement. Here I want to take a quick look at the electric power sector and the slow transition to more clean energy power systems.

What’s the Hold Up?

One uncertainty ahead for renewable energy is how investors will take to the coming period in which project revenues have less government price support, and instead depend on private sector power purchase agreements or merchant power prices.

Why can’t this transition happen more quickly, particularly in regards to electric power generation and consumption. When countries submitted their INDCs in 2015, the energy world was a bit different than today. One of the most significant differences from then to today is the price of clean energy resources, particularly solar, wind and batteries.

With significantly lower costs for clean energy power generation since the Paris Agreement shouldn’t we be seeing a more rapid transition. A key  argument has been that the higher costs of renewable energy was a key barrier. It is very difficult to make the same argument today. As demonstrated by the most recent levelized cost of energy studies.

Economics are there for clean energy

According to the Lazard Levelized cost of energy report, in 2015 combined cycle gas plants and utility solar were pretty much event in cost per kWh. Solar was a bit cheaper at $64 and Gas combined cycle was $65. Wind was less expensive than both at $55. If we look at the most recent Lazard report for 2017, prices have continued to drop for all technologies, but solar and wind by considerably more. In 2017 wind was $15 less than gas at $45 and solar was $10 less than gas at $50. Solar made the largest gains in price reduction per square foot and closed the gap on wind. There is now only a $5 difference between wind and solar applications.

The other argument has been that renewable energy is intermittent and too much renewable energy on the grid would hurt grid reliability. This argument appears to be losing some of its validity. One would expect that with early deployment, there was not the diversity of resources, solar and wind, nor the geographic disbursement of these systems to ensure grid stability. However, as we see greater deployment of solar and wind, we see the complementary nature of these resources and how they are better able to support the overall grid when coupled together. Throw in batteries and you really solve the intermittency issue. Granted, solar and batteries is still a bit more expensive, than your base load combined cycle natural gas plants, but not by much.

Texas Not Showing the Way

A recent decision by the Texas Public Utility Commission (PUCT) on AEPs Wind Catcher facility is a good example of how developers may not be using the appropriate assumptions for their models and how the PUCT is slow to adjusting to the clean energy transition. What this means for both the developers and the regulators is that they have not been able to properly model the long-term benefits of clean energy resources and future risks of a fossil-fuel based power grid.

The AEP’s Wind Catcher would have been a 2 GW wind farm in the Oklahoma Panhandle. The largest wind farm in the United States. AEP argued that customers would receive significant benefit due to the expected fuel savings of the project. Because power would be provided to Texas, the PUCT had a say on whether the project was seen as beneficial to Texas customers. The PUCT denied the project on grounds that it placed too large a burden on rate payers.

What has changed in the market?

The clean energy market is tougher place to be than it was a year ago. Three key factors a lower federal tax rate, low natural gas prices and in Texas the fact that the renewable portfolio standard has long been met and provides no requirement for utilities to take on additional clean energy.

Because the renewable energy standard goals of Texas have been met, AEP had to demonstrate that the costs of the plant were competitive and provided cost savings to customers. Another strike against the project was when first conceived, the federal tax rate was higher. Higher tax rates provides a greater benefit to projects looking to participation in the federal production tax credit. When taxes go down, less tax burden and less benefit via this credit. AEP saw a $245 million decrease in tax benefit with reduction in federal taxes.

Old Way of Thinking Continues

Those are two valid concerns that have a material effect on the value of this project. There are two concerns expressed by the PUCT that are more difficult to accept. The first is that the PUCT does not feel there will be a carbon tax or any other climate regulation supporting clean energy investment in the near to mid-term. However, that is likely to be only as long as the current administration stays in power. Looking beyond 2020, we should anticipate a swing back toward carbon related regulations which would get the US back in line with the rest of the world.

Further, as we continue to see greater climate related extreme weather activity, it is increasingly likely that more interest will be paid in mitigating climate risk through the development of policies for more clean energy resources. This could be done through a “punctuated equilibrium” event such as an extreme long-term drought or the largest fire in California’s history, that would mobilize voters for more climate focused policies. Not only may a large event drive policy change, think Fukishima, but so would current state and local efforts. We are seeing a significant horizontal diffusion across states and communities of climate policies. As this builds, we could very well see a vertical diffusion, a snowball effect that drives action at the federal level. We see from COP 23 that a sizable portion of US cities and states are “still in.” To not take into account, the possibility of future climate regulations is short-sighted energy planning that goes against many of the indicators that would suggest otherwise.

Natural Gas Prices to Remain Flat for 30 years?

The second argument by the PUCT against the Wind Catcher project was that natural gas prices are low and will remain low for the foreseeable future.  With such low natural gas prices, wind is not believed to be competitive and would increase cost burden to customers.

The analysis by the PUCT does not take into account the ongoing decrease in wind energy prices. As mentioned earlier, according the most Lazard report, the LCOE of wind is less than natural gas combined cycle plants. A recent Rocky Mountain Institute (RMI) report finds that an “optimized clean energy portfolio” is cost competitive with natural gas at $5 MMBtu gas now and with $3 MMBtu gas in the next 15 years. The study also looks at a Texas case study.  When comparing a combined cycle plant with a clean energy portfolio which includes energy efficiency, solar, wind, demand response, etc., the clean energy portfolio has a 25% savings over the cap ex of a the combined cycle plant.

The Chairperson of the PUCT, DeAnn Walker, stated that one of the key problems with the project is that “the costs are known…the benefits are based on a lot of assumptions that are questionable.” However, looking at the decision of the PUCT, one should ask the same thing of the PUCT assumptions of low natural gas prices. Natural gas prices are historically volatile. To base the conclusions on the premise that natural gas prices are going to remain stable and flat over the next couple of decades indicates that the PUCT has not learned from history. By assuming that natural gas prices will follow a very stable, minor increase for the next thirty years does not reflect the reality of the last 30 years. This false assumption puts energy consumers at greater risk.

Here is the PUCT’s assumption – natural gas prices is the orange line.

Here is the historic reality of natural gas price volatility.

There were some other strikes against the Wind Catcher project, particularly the additional costs of transmission construction to interconnect the system. Further, AEP should have done a better job on how it presented its analysis and assumptions with the more recent changes in the natural gas market and regulatory environment.

That being said, AEP and other developers should learn from this project. One key area that has yet to be touched to the degree necessary is future climate risk and the increasing likelihood of climate regulations. Energy planning models are not properly taking into account either of these risks. By not doing so, models will not adequately value clean energy projects and limit opportunities for speeding up the energy transition. More to come on energy planning in the next post.

 

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Paris Agreement: The Slow Walk Continues

COP 24 is quickly approaching. This COP will be held in Katowice, Poland. The intent of the 24th Council of Parties is to facilitate and adopt a set of strategies that will lead to the full deployment of the goals expressed during COP 21, i.e. the Paris Agreement. There will also be greater focus at this COP to identify not only mitigation strategies, but also more carbon sequestration strategies via improved land-use practices.

 

A Quick Review of Paris Agreement

In 2015 all of the countries of the world convened at COP 21. The 21st meeting of the UN’s Council of Parties. The goal of COP 21, aka 2015 Paris United Nations Framework Convention on Climate Change  (shortened to the Paris Agreement), was to identify the strategies that would help countries, and the globe at large, to reduce greenhouse gas emissions. The expectation was that by countries cooperating and coordinating on a variety of emission reduction and carbon sequestration efforts, we would decrease the likelihood of the planet warming more than 1.5 degrees. 1.5 degrees being the threshold that was set by climate scientists to be the maximum amount the plant can warm beyond the pre-industrial revolution baseline of the late 19th century. Beyond 1.5 degrees, and it is expected the earth would see some pretty catastrophic impacts. This would largely be an increase in number and intensity of extreme weather events, both short-lived such as hurricanes and of longer duration, such as droughts.

To establish the Paris Agreement, all countries worked to provide Intended Nationally Determined Contributions (INDC) for mitigation. These are largely the sectors countries will focus on to reduce their greenhouse gas emissions. This includes the energy sector; agriculture; land-use; waste; transportation, etc. By April 2016, 97% of all participants, 190 of the 196 possible participants, in the United Nations Framework Climate Change Covenant (UNFCCC) had submitted INDCs. This covered about 94.6% of all carbon emissions.

What has happened since the Paris Agreement?

What happened between COP 21 and COP 24? Some would argue progress was made, but largely not enough progress to adequately address the extreme risk we face with a rapidly changing climate. Some progress is better than no progress. We did see advancements in commitment for financing and funding both mitigation and adaptation activities; greater focus on supporting indigenous populations; and the development of additional coordination mechanisms that facilitate dialogues across countries, as well as between the public and private sector.

There was COP 22 in Morocco. This was largely a follow-up to COP 21 to demonstrate that countries are on board . A joint statement was issued to this effect demonstrating that countries are committed to the goals they established in COP 21. The COP did ask for not only ongoing commitment but also a willingness by countries to increase their financial contributions to this effort, both internally and to countries in need of greater financial support. It also recommended that countries up their goals a bit, as there was a increasing realization that the goals set during COP 21 were not sufficient to meet the 1.5 degree threshold.

There was then COP 23, held in Bonn, Germany and led by the country of Fiji. The focus of COP 23 was to further develop implementation strategies for COP 21 goals, as well as further develop a facilitative dialogue known as the Talanoa Dialogue. The intent of this dialogue is to build trust among participating countries. With greater trust, it is believed there will be improved knowledge sharing, as well as increased likelihood of greenhouse gas reduction strategies being implemented. Some other highlights includes United States’ cities and states recommitting after the US federal government pulled out of the Paris Agreement.  With Fiji taking the lead, there was also significant focus and progress on indigenous populations, particularly those that are most at risk to sea-level rise and other climate risks.

Where do things stand?

We have all of this improved coordination and cooperation happening across countries, as well as with greater public/private partnership efforts. Further, we have greater investment in mitigation and adaptation efforts. However, we still are very much falling short. In October 2017 the UN Environment’s Emissions Gap report was issued. The report was issued prior COP 23 in Bonn. It assesses the INDCs and the progress countries are meeting. The conclusion was not great. The INDCs meet only about 1/3rd of what needs to be done to keep under the 1.5 degree threshold and those pledges that have been made are not all reducing emissions as quickly as anticipated.

As a planet, we are way behind where we need to be to decrease the likelihood of hitting the 1.5 degree threshold. In the next blog post, I discuss the electric power transition and the current barriers that are slowing it down and the ways in which to reduce these barriers.