Renewable Energy: The Easier Path Forward

 | Jun 21, 2013 | 6:00 PM EDT
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When it comes to building new power plants, many developers are hitting brick walls. One challenge is investor reluctance to participate in risky capex projects. The other is the regulator's reluctance to permit new sources of air, land and water pollution. The only path around that wall is to consider wind, solar and energy efficiency.

Texas offers a case study that may help explain the challenge. Today, the state is chronically short power plant capacity. Over time, its capacity is expected to get worse. The state's largest grid, Electric Reliability Council of Texas warned, "With tight operating reserves expected this summer, it is likely that ERCOT will initiate conservation alerts or power watches on some days."

The reason ERCOT is short capacity is because nobody is building new power plants and some are retiring old plants. State policymakers thought by opening up the utility grid to a free market, developers would rush in and build new power plants. There was talk NRG Energy (NRG) might expand its South Texas Project and add two new reactors. Maybe Exelon (EXC) would expand its Texas footprint by building a new nuclear plant or new combined cycle gas turbines. None of these projects has traction.

The issue has been returns. If investors are to put up billions of dollars, they want to see a return on their investment. Nobody can show them a return. ERCOT's market system is incapable of producing forward prices sufficient enough to defend in a pro forma. As a result, traditional utility investors and loan officers cannot be sure they would ever see a return. Without reasonable assurance they walk away.

Even speculators have been timid. Many ignored opportunities to build new projects and instead sought out distressed property. There has been a lot of distressed property.

Some developers (and their investors) miscalculated and found themselves stuck in a weaker than expected power market. Their revenue was not strong enough to support debt service and they were forced to sell for pennies on the dollar. Companies such as Exelon bought up efficient turbines for far less time and money than it would take to build new.

Even if the power markets provided price signals for investors, if a developer does not have requisite air, land and water permits, their project is going nowhere. Their plight is worse if the regulator lacks the authority to issue new permits.

In Texas (and several other states), there are regions where no regulator has the authority to issue new permits. Today, there are approximately 20 counties surrounding Houston, Dallas and El Paso, which have air pollution levels exceeding national quality standards. In many of these areas, ozone, volatile organic compounds, particulate matter or other pollutants have reached high enough levels that no state or federal regulator would have the authority to issue new permits.

In regions outside of the structured power markets and away from population centers, projects are possible. However, for traditional power plants in load pockets, market and regulatory forces make new projects seem impossible. Even General Electric's (GE) and Siemens' (SI) state-of-the-art, clean burning and efficient combined cycle gas turbines cannot be built if air permits are not available. And, in many regions of the country, new air permits are simply not available.

The exception is renewable energy -- wind, solar and energy efficiency. To build renewable energy projects, unit costs are light, regulations are relatively easy, revenue streams are stronger and investment risks are limited. Renewable energy assets can earn revenue from traditional sources. They can also earn energy credits from the state government and tax benefits from the federal government.

This might help explain why Texas -- a conservative state -- is the nation's leader in wind power. Today, the state has more than 11,000 megawatts of wind power operating in ERCOT. In addition, the American Wind Energy Association reports that Texas has another 22,000 megawatts on the way.

Renewable energy provides state policymakers with optionality. Through energy credits, states can motivate consumers to own renewable energy assets. As consumers place more of those assets into service, the state gains power plant capacity without increasing pollution. The state also gains new options to grant other companies air permits.

The worst air pollution in the country is found in Southern California. There, it is nearly impossible for anyone to offer a new air permit to anyone. It is for this reason that Edison International (EIX) will be unable to easily replace its crippled San Onofre Nuclear Generating Station with new gas turbines. Like New York and New England, California's only option is to import power from elsewhere and promote the use of renewable energy.

Long term, renewable energy will take on a larger role. Solar and wind power are here to stay as more states will see renewable energy as their easiest path forward. 

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